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Money Save Tips :: Tax Efficient Investment
Tax Efficient Investment:
How a Tax Efficient Fund Investment Works
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A tax efficient investment fund is one that generates less than 1/2 the tax bill of a typical stock fund. Tax-efficient funds follow existing investment strategies that happen to be tax friendly, while tax-managed funds are specifically engineered with taxes in mind.
To learn more about how tax efficient funds or tax efficient investing works, keep reading.
What do you mean by "tax-efficient" anyway?
A tax efficient investment fund is one that generates less than half the tax bill of the typical stock fund. How much less depends on the fund.
How does that differ from a "tax managed" fund?
Very little. The difference between tax-efficient and tax-managed funds lies not in their benefits, but in their design. Tax-efficient funds follow existing investment strategies that happen to be tax friendly, while tax-managed funds are specifically engineered with taxes in mind.
How much money can you save?
It depends which direction you look. Over the past 10 years, the tax penalty paid by stock funds has been enormous - more than 200 basis points per year on average, assuming a 31% income tax bracket.
With lower absolute returns, a reduced market yield, and the 20% capital-gains tax rate facing us in the future, the average tax bill may shrink to 120 basis points or so.
If I buy a tax-efficient fund that hasn't paid out gains in the past, don't I assume a big tax liability?
Not necessarily. Many tax-efficient funds are new, so they haven't accumulated many gains. Almost any fund with a good track record - presumably, the kind of fund that you're targeting - carries substantial unrealized gains. (If you want net unrealized losses, buy a Steadman fund.)
Should I use index funds to be tax efficient?
Indexing and tax efficiency are not synonymous. Many indexes frequently change their components, leading to a lot of shuffling-and capital gains. Other indexes have relatively high dividend yields. So yes, some index funds are a form of tax efficient investment, but you can't just assume them to be so as a species.
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