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Tax efficient mutual fund or not
Old 07-27-2004, 08:49 PM   #1
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Tax efficient mutual fund or not

I am trying to figure out what to put into my personal investment acct (not tax defer)

According to my 2003 TurboTax return, my effective tax rate is 16%

For a fund that's actively managed (compare to index fund), I assume there'll be more buying and selling, thus more realized gain, and eventually dividend and proceed for distribution at end of year, and taxable

For non tax defer account, what's the best investment strategy? index fund or active manage fund?

Thanks!

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Re: Tax efficient mutual fund or not
Old 07-27-2004, 08:55 PM   #2
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Re: Tax efficient mutual fund or not

Index funds are more tax efficient than managed funds, and ETF's are the most tax efficient of all.
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Re: Tax efficient mutual fund or not
Old 07-28-2004, 06:46 AM   #3
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Re: Tax efficient mutual fund or not

Why wouldn't you want to use your marginal tax rate? Isn't that what the IRS wants you to use to figure out what % ST & LT gains and dividends are taxed? I don't know.

Not all index funds are tax friendly. Small cap index funds and REIT index funds are not tax friendly. Small cap ETF's should be tax friendly though. The large cap index funds (S&P 500, TSM) are very tax friendly. I'm not sure using actively managed funds anywhere is a good strategy, unless they're very low cost (low expense ratio and low turnover). However, if you are going to use actively managed funds that aren't tax friendly (hint: look at previous cap gain distributions in prospectus), I'd try and keep them in tax deferred accounts.

- Alec
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Re: Tax efficient mutual fund or not
Old 07-28-2004, 09:47 PM   #4
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Re: Tax efficient mutual fund or not

Index fund but you have to be a long-term investor. An index fund isn't very tax efficient if you're moving in and out all the time. Put it in an index fund (VTSMX is my favorite) and let it ride for a long time.

Mike K
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Re: Tax efficient mutual fund or not
Old 07-28-2004, 10:50 PM   #5
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Re: Tax efficient mutual fund or not

Seems like consenses is to keep index fund long term in non tax defer account

I've maxed out my 401k and traditional IRA, and I still have cash available to invest.

I don't want to do CD, as I consider return too low.

I can tolerate moderate risk, and don't mind putting money away for a few years to get better return (7+ is fine by me).

My only concern is if the fund has huge distribution, and keep it long enough (5+ years), I will pay lots of taxes on it, thus limiting growth potential

Do I have the right thinking?
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Re: Tax efficient mutual fund or not
Old 07-29-2004, 11:28 AM   #6
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Re: Tax efficient mutual fund or not

Jack Bogle, Sr., a guy who seems to be pretty knowledgable when it comes to indexing, has 10% of his 2004 non-tax-deferred protfolio in Vanguard Tax-Managed Balanced fund.

Of course Bogle's net worth is probably greater than the total of all of our accounts and he is 80 years old.

So...who knows if his fund selection is appropriate for the rest of us. I sure as hell don't.
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Re: Tax efficient mutual fund or not
Old 07-29-2004, 11:34 AM   #7
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Re: Tax efficient mutual fund or not

Quote:
My only concern is if the fund has huge distribution, and keep it long enough (5+ years), I will pay lots of taxes on it, thus limiting growth potential

Do I have the right thinking?
Yes, the funds that distribute a lot of capital gains lose a lot of their return to taxes. In taxable accounts, you want your fund to never, ever, take a Short term capital gain b/c ST cap gains are taxed at your marginal tax rate, and hardly ever take Long Term capital gains.

What you'd actually like your taxable fund to do is to offset any capital gains it must take (from selling stocks in its portfolio that have gone up in price) with capital losses (from selling stocks that have gone down in price), thereby not distributing any capital gains to you. Vanguard is especially adept at doing this in their tax managed funds. Vanguard's S&P 500 index (VFINX) and TSM index (VTSMX) have extremely low turnover, and therefore don't have to take many capital gains.

Another very tax efficient fund is Bridgeway's Blue-Chip 35 Index fund (BRLIX). It is specifically tax managed.

ETF's are also very tax efficient, however people making monthly or quarterly contributions can rack costs each time he/she purchases an ETF.

- Alec
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Re: Tax efficient mutual fund or not
Old 07-29-2004, 04:19 PM   #8
 
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Re: Tax efficient mutual fund or not

You have no idea how liberating it is to get your income
so low that you owe no income taxes. What makes it even sweeter is that this was completely unanticipated
when I decided to ER. I was looking around for a state with no income tax. It became a non-issue
and most welcome. One less thing to worry about.

John Galt
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