Mutual funds holding many highly-appreciated stocks may have a large potential capital gains exposure. If the fund sells those stocks, investors could be hit with steep tax bills. How can you avoid this trap?
Invest in tax-managed funds Some funds trade rarely and take capital losses to offset any capital gains, in order to minimize investor’s tax bills. They usually have “tax-managed” in their name.
Invest in index funds. Funds designed to track a particular index buy and hold the stocks in that index. They tend to do little trading so they don’t incur capital gains.
Consider funds with loss carry-forwards. These funds have taken losses in the past, which can be used to offset future gains. Thus, investors might not owe tax from these funds, for several years.
Taxes won’t be an issue for mutual funds you hold in an IRA. However, if you’re buying funds for a taxable account, check on its tax-efficiency before investing.
