Mutual funds and taxes. Now there's a topic that'll get the old heart racing. So I'll make this brief.

Most stock fund managers do a lot of trading. When their trading gains are larger than the losses, the fund accumulates "net realized capital gains" (usually referred to as realized capital gains). By law, funds must distribute virtually all their realized capital gains each year to shareholders, who in turn must pay taxes on them. The more a fund's return consists of realized capital gains -- as opposed to gains that have yet to be realized -- the lower the fund's return after taxes.

Tax-efficient funds, however, keep these distributions to a minimum. In some cases, a fund is tax-efficient simply because it follows a buy-and-hold strategy, which generates fewer realized gains. Index funds, for example, pass along few realized gains because they sell shares only to rebalance holdings to reflect changes in the underlying index, or to meet shareholder redemptions.

Funds specifically designed to be tax-managed funds employ certain strategies -- such as selling some stocks for losses that can then be used to offset gains -- that can reduce or even eliminate capital gains distributions.

In April, the Securities and Exchange Commission began requiring funds to disclose after-tax returns in fund prospectuses (read the SEC report on their website. Or find a fund's tax efficiency by plugging its name into Morningstar.com's Quicktake Report search engine and clicking on Tax Analysis.