Investors face big tax bills for these mutual funds
What’s worse than watching your mutual fund investments decline in value? Getting hit with a big tax bill, too.
That’s the reality some Americans are facing this year as the deadline to file taxes approaches. It’s largely a function of how actively managed mutual funds operate: Portfolio managers buy and sell securities within the fund to reposition their strategies, and many did so in 2022’s volatile market.
After a years-long bull market, many stocks in mutual funds had increased in value since they were purchased, despite the S&P 500’s 19% drop last year. That means they were subject to capital gains taxes when they’re sold. Those taxes are passed onto the fund’s holders, who have to pay even if they only bought into the fund recently.
Another factor is outflows from mutual funds. When investors decide to take their money out, the fund manager has to raise cash for the redemptions by selling securities, therefore triggering more capital gains. Mutual funds faced about $1 trillion in outflows last year as many investors gravitated toward exchange-traded funds which are known for being more tax efficient.
The capital gains distribution on a mutual fund is expressed as a percentage of its net asset value, which is the fund’s assets minus its liabilities divided by the number of shares outstanding. The bill is proportionate to how many shares an investor owns.
Of course, this is only the case for mutual funds in taxable accounts. Retirement accounts like 401(k)s won’t face capital gains bills.
Click through to see the funds with the largest capital gains distributions last year, according to data from Morningstar and Bloomberg: