Tax efficiency and mutual funds |  Dear
Money Matters,
Do I have to watch tax efficiency
when selecting a mutual fund? How important is it? -- Bwestra
 Dear
Bwestra,
Absolutely, tax efficiency is one of the elements you should
examine when choosing a mutual fund. For those who may be unfamiliar with the
term, tax efficiency refers to the amount of taxes that a fund pays out as part
of its regular investment activities. That may seem like the fund's headache and
not yours, but taxes are subtracted from the fund's return that's ultimately paid
out to its investors. The higher the tax burden, the bigger the chunk of change
pulled from your pocket.
The good news is that the Securities
and Exchange Commission requires funds to disclose their tax efficiency. It's
simple to track down, either through the fund's annual report, quarterly filings
or any number of online mutual fund tracking sites or print publications. Many
sites, newspapers and magazines illustrate how much taxes drain from a fund, either
through calculating the after-tax return to investors or by showing how much of
a given investment -- say $1,000 -- is lost over time to taxes. You can use those
figures to compare funds. An unduly heavy tax burden can gut
even the best mutual fund performance. For instance, it's common to see a fund
whose performance appears to be excellent, only to actually come out rather poorly
after taxes are calculated. I recently saw one fund whose five-year annual rate
of return topped 8 percent -- a seeming category leader. Unfortunately, it was
also a leader in tax inefficiency, which pushed this apparent high flier toward
the bottom of its peer group. So it's essential to take those
ads touting astronomic returns with a shaker or two of salt. Even the sweetest
fund can turn sour if its tax efficiency is crippling. And that makes tax efficiency
an essential element of any mutual fund research, along with portfolio mix, investment
philosophy and management. | 
