Reducing Tax Liabilities with Mutual Funds

One can easily be fortunate or unfortunate in the world of investments. The key to prospering is to understand the consequences of actions taken in order to remain in the game. Winners only keep winning if they are consistent in their approach.

Mutual funds are attractive as an investment tool because they allow the investor to combine the power of many incomes in securing a better than average return on an investment. A mutual fund is a pool of money that is invested in many different stocks, bonds or other investments (Financial matters..., 1995, PG). The skills of a fund manager are used in investing and selling in high return, low risk shares that can yield an average annual total return as high as 18.1 percent (Siedell, 1995, 55).

The difficulty with mutual funds lies in tax considerations. Federal regulations stipulate that a mutual fund must pay out to shareholders virtually all of the income and capital gains it realizes each year. Capital gains are "realized" when a fund sells a security for a profit. That payout is then taxable to shareholders, dividends and shortterm capital gains at the shareholder's tax rate, and long term capital gains at 28 percent (Siedell, 1995, 55). In order to stay in the game and avoid paying the tax liabilities that ensue from the successful use of mutual funds, several strategies have been evolved.

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case of taxefficient funds, there is an advantage in lower pay outs. These funds invest in lowyielding stocks. Aggressive capitalappreciation funds invest in fast growing but nondividendpaying companies. Some funds hold on to winning positions, thus delaying passing along returns to shareholders, thus avoiding the realization of capital gains (Siedell, 1995, 55). It should also be understood that some fund objectives are more taxefficient than others. Municipalbond funds are of course typically more efficient than corporatebond funds that are intended to produce regular income. The idea is to gage the amount of the investment against the relative efficiency of the mutual fund(s) that may be investing in. Each kind of mutual fund must be seen as a kind of factory or engine that produces just the kind of "resource" for a limited period of time (Siedell, 1995, 55). Some recognized rules of the road should keep the neophyte investor from courting a big tax bill. The timing of buying into a mutual fund should be considered carefully. Most funds pay capital gains distributions once a year, usually in November or December. This is why it is unwise to invest at yearend; one can "buy" a full year's worth of taxable gai
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