Know Where To Hold ’em

Now that the SEC is requiring mutual funds to report both pretax and aftertax performance, you should look at the long-term aftertax numbers, rather than the pretax numbers, when examining a fund’s return. Those are the numbers with which to compare funds you’re considering. These numbers may be very helpful if you are considering several funds for both tax-deferred retirement and taxable accounts.

• Put the least tax-efficient funds inside your retirement plan. A fund that has excellent pretax but mediocre aftertax returns will benefit from the tax shelter.
• Hold the most tax-efficient funds outside of your retirement plan. Some mutual funds, including tax-managed funds, are extremely tax-efficient, long-term. Holding such funds in a tax-deferred account effectively wastes the tax shelter.

On the other hand, the aftertax numbers really make no difference if you’re investing inside a tax-deferred retirement plan. You should select a fund you expect to generate a substantial pretax return, for a given level of risk.