Boomers Beware of Mutual Fund Distributions

With 2008 approaching it’s end, we are heading towards one of the worst market drops in it’s recent history.  Retirement accounts have lost trillions of dollars with no potential of tax loss benefits.  But, what about taxable accounts?  Surely, this is a year that capital losses can be taken?  While this is usually the case with most stock investments, but most investors and boomers have to be careful about are mutual funds in taxable accounts.

Paying Taxes In A Down Market

As absurd as that sounds, this is a reality in down years of the market.  Nobody likes to pay taxes, especially in a down years.  Nothing like the IRS kicking you while you are down.  Ouch!  But why does this happen?  Here are a few reasons:

Selling Off

If the money managers are expecting a downturn in the market, they may go ahead and sell off some of their long term holdings to lock in gains.  While it’s always good to lock in gains, those gains are then passed on to the you the shareholder.  Merry Christmas!

Liquidate, Liquidate, Liquidate

When the markets heads south, people panic, and they want to sell.  In the month of September, $75 billion worth of mutual fund redemptions were reported.  That was just for the month of September!  When that happens, mutual fund managers are then forced to sell off positions to cover these liquidations.  Forced sales of appreciated stock equals capital gains passed on to the shareholder.

Rebalance and Reallocate

Lastly, during steep downturns, the managers will attempt to be proactive and reallocate to new positions that they feel are poised to benefit when the market will recover. As a result, a downturn is often the period that you see managers change the focus of their portfolios, which equals taxable events.  Similar to the tech bubble in 2000-2002, expect managers to take gains on energy, materials, commodities, and real estate stocks. Consider These Tax Efficient Strategies:

Investing in Tax-Efficient Funds

One of the best ways is to seek out strategies that display tax efficient characteristics, such as lower turnover, and positive cash flows.  Not only will this equal lower expenses in your funds, but will alleviate the tax burden come year-end.

Tax Loss Harvesting

Tax loss harvesting involves selling positions at losses in order to realize taxable losses to offset taxable gains.  Transaction costs are typically an issue when it comes to this strategy, so tread lightly.  You may also may want to seek council from a tax advisor in regards to this.

Other good reads:

Moolanomy: Lose Money and Pay Taxes on Your Mutual Funds

Good Financial Cents: Letter To Clients: Capital Gain Distributions

Dough Roller: My Annual Investment Portfolio Tune Up

Tough Money Love: Year End Retirement Planning

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