Fund Spy: When Bad Taxes Happen to Good Funds

[Morningstar Logo]( [Company Site]( [Company News]( [Membership]( [Portfolio]( [Stocks]( [Options]( [Funds]( [ETFs]( [Markets]( [Tools]( [Personal Finance]( [Discuss]( Fund Spy When Bad Taxes Happen to Good Funds Learning from past misfortunes can help investors avoid future tax woes. [tab_bar] by Amy C. Arnott, CFA | 12/1/2020 2:00:00 PM For mutual fund investors, taxes can be an unpleasant surprise, partly because they're largely out of the individual’s control. Mutual funds build up unrealized gains and are required to distribute those gains to shareholders on a pro-rata basis after they’re realized. As a result, shareholders can end up getting hit by unexpected tax bills, even if they didn’t benefit from previous appreciation. For investors in taxable accounts, the impact can be significant. Over the past five years, Morningstar’s Tax Cost Ratio--a measure of the reduction in returns from taxes on fund distributions--has averaged about 1.8% for U.S. equity funds. Like fund expenses, taxes directly reduce an investor’s take-home pay--the amount of money you end up with after paying taxes and fees. But the return hit from taxes is nearly twice as large [1] as that from annual expenses, which average 0.98% for diversified U.S. equity funds. In this article, I’ll look at a few examples of otherwise successful funds that have had bad results for investors in taxable accounts and give some suggestions for how to avoid similar problems going forward. When Things Fall Apart I started by screening on diversified U.S. equity funds with Morningstar Analyst Ratings of Bronze or higher. Our analysts assign these forward-looking, qualitative ratings based on their in-depth analysis of a fund’s People, Process, and Parent, as well as its underlying fees. (Note: our rating process doesn't incorporate tax considerations because many shareholders hold funds in tax-advantaged accounts, such as 401(k) plans.) To read more, click [here](. Sponsored Links [Buy a Link Now]( Free Issue | Morningstar's Fund Newsletter >> Morningstar FundInvestor brings you critical data and analysis on the 500 biggest and best mutual funds around. Includes online access to the monthly, full-page Analyst Reports, plus exclusive research and commentary from Morningstar's Director of Manager Research, Russ Kinnel. [Click for your free issue](. Search Most Recent Articles [Weekly Wrap: How the Pandemic Has Changed the Math on Emergency Funds and College Savings]( [The Trouble With Social Security COLAs and Medicare Premiums]( [Are Sector Funds Worth a Look?]( ABOUT OUR EMAIL To unsubscribe and update your preferences, go to our [email newsletter page](. All subscription changes will take effect within one business day. If you have questions about Morningstar.com or your membership, send a note to premium@morningstar.com. ABOUT OUR PRIVACY POLICY Please [click here]( to learn about Morningstar's privacy policy. (c) Copyright 2020. Morningstar, Inc. 22 W. Washington Chicago, Illinois, 60602 All rights reserved.