There are a variety of investment products out there and they are not all taxed in the same manner.  As an investor, it is important to understand the tax implications associated with any investment you make.   This is certainly the case with mutual funds.   Like an individual stock, mutual funds make distributions to shareholders, but these distributions may be treated differently to a mutual fund investor.  A mutual fund must distribute 95% of its gains to its shareholders, which include both dividends from individual companies and capital gains from the sale of assets inside the mutual fund.  After a payout is made, the net asset value of the mutual fund decreases.  This is different from an individual company paying a dividend because even though its cash on the books decrease by what it distributes to shareholders, the trading value of that stock is determined by the market (supply and demand) and does not mirror the NAV as in the case of a mutual fund.

When buying a mutual fund, it is important to know the potential capital gain exposure in the fund.  Potential capital gain exposure is the amount of gain in the portfolio at the time you are considering buying the fund.  If you have the choice between two identical mutual funds – one with a 300% potential capital gain exposure and one with a -300% capital gain exposure, it would be smart to invest in the one with a negative capital gain exposure.  This means that the fund has had to sell securities at losses and it has built in capital losses that can be used to offset future capital gain distributions.

Another item for tax planning is when to buy a mutual fund.  If you know that a mutual fund is going to pay a large distribution, you are better off investing in the fund after the date of the distribution.   Although you are usually not going to know the exact date and amount of the distribution, most fund companies can provide you with an accurate estimate.  This piece of information is vital to your tax bill.  For example, in 2014 a significant amount of equity mutual funds had large distributions at the end of the year because of appreciation in the market over the past few years.  An investor would not want to buy into one of these funds close to year-end and get hit with a large distribution that is going to add to taxable income.  It is smarter to wait to invest until after the distribution is made, thereby lowering your capital gain exposure.

At THOR, we are cognizant of the tax implications of each investment we make and believe it is among the important items to consider when deciding which investment is best for your portfolio.