Taxes won’t be an issue for mutual funds you hold in an IRA until withdrawal. However, if you’re buying funds for a taxable account, check on its tax-efficiency before investing.
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.