NEW YORK (CNN/Money) -
It's been a cruel year for mutual funds. The average stock fund is down 19 percent year to date. Not a single growth fund is making money. On the value side, only five funds are in the black.
Now, to make matters worse, it's mutual-fund tax season. And if you think you're getting a break from the headaches because so few funds have made money this year, you're wrong. It's always tricky to navigate the complicated rules about fund gains and losses. Here are three strategies to limit your tax bill.
First things first: Manage your gains and losses
April 15 is months away, but the end of the calendar year is a crucial tax time for fund investors. That's when funds by law have to distribute capital gains on stocks they've sold for a profit (even if the fund has lost money, it still may have gains on individual securities -- fund holders each pay their share of the tax bill).
Each fund sets up its own "record date" to determined who is a "shareholder of record" and hence subject to the fund's capital distributions. Capital gains typically come in November and early December, though the record date may vary from year to year. If you want to avoid the tax tab, you need to sell your shares BEFORE the record date or buy AFTER the record date.
And don't think your fund will pass along a loss just as it distributes gains. Instead, funds keep the losses on the books and use them down the road to offset future gains. It's not clear why the law was written that way, said John Collins, a spokesman for the ICI, the fund industry trade group.
Don't assume you won't have any gains
Though the market is down a lot this year, many funds are sitting on gains amassed over the years. And because of the record outflows from funds, it's possible your manager had to sell shares to meet redemptions.
You can get some idea of a fund's potential tax liability by looking at its capital gains exposure calculated by Morningstar. It tells you what percentage of the fund's assets would be subject to capital gains or losses if it were to liquidate today. Let's say you have a fund with $100 in assets. If it has a capital gains exposure of 25 percent, that means it has capital gains worth $25 in its portfolio. If it has a negative capital gains exposure of -25 percent, it means it has a loss on paper of $25.
Morningstar takes information from a fund's annual report to calculate the figure, including estimates on unrealized gains and losses. (See accompanying chart.)
A fund with a high capital gains exposure of 30 percent or more could pose a threat down the road. Or, if its assets plunge, the manager may have no choice but to sell stocks and trigger a tax tab for you.
This year, there are 86 funds with a capital gains exposure of more than 30 percent. At the top of the list is the $22 billion Fidelity Advisor Natural Resources C shares, with a capital gains exposure of 99.2 percent of assets. It means the fund is sitting on potential capital gains of nearly $22 billion.
Even tax-managed funds have potential gains on their books. No. 14 on the list is the $144 million Armada Tax-Managed Equity I shares, with a potential capital gains exposure of 86 percent of its assets. Bill Batchellor, manager of the fund, said it's natural for tax-managed funds to build up some gains. The purpose of a tax-managed fund is to limit the tax bite. So if it owns a stock that's been on a roll, it might sell some of the stake but not all of the position. That would leave, on paper at least, a potential capital gain.
Batchellor said the fund's record date is Nov. 30, but he said the distribution probably will be tiny, less than 1 percent of the NAV, or roughly 5 cents.
"Tax-managed funds aren't tax-free," Batchellor said.
Losing funds can lower your tax bill
The flip side is there are hundreds of funds that are carrying billions in losses on their books. For example, the $11 billion Legg Mason Value has a potential capital gains exposure of -9 percent of assets. That means the fund has a loss on paper of about $945,400. Fidelity's flagship Magellan fund, with assets of $58 billion, has a potential capital gains exposure of -16.3 percent of assets, or $12.2 billion, Morningstar said. (See accompanying chart for more on the capital gains exposure at the 10 largest funds.) The $13.1 billion Janus Worldwide has a potential capital gains exposure of -57 percent of assets, or $7.4 billion.
| * Some assets are for a share class, not the whole portfolio. The capital gains exposure is different in each share class. | | Source: Morningstar |
|
But the bear market has skewed the numbers -- a total of 16 funds have a negative capital gains exposure of -1,000 percent or more. Some are on the list because they are tiny, such as Nationwide S&P 500 Index Local, with just $80,000 in assets and a capital gains exposure of -1,197.6 percent. And some are on the list because they are tech or growth funds that fell to earth after the tech bubble burst. The $37.3 million Van Wagoner Technology, for example, has a potential capital gains exposure of -1,123.1 percent.
While you shouldn't necessarily jump into a tech fund that's so deeply in the dumps, there are hundreds of other funds with a modest loss on the books. And if you're trying to decide between two funds with a similar investing theme and a similar track record, it wouldn't hurt to choose the one with the tax loss on the books, said Doug Flynn, a certified financial planner in New York. All it means is you might not have to pay taxes on gains as quickly. And after a dismal two years on Wall Street, what could be better than that?
|
