ETF ACADEMY: Mutual Fund Tax Nightmare

In the June 2008 issue of Money, managing editor Eric Shurenberg laments about the tax bill that accompanied the poor 2007 performance of one of his favorite mutual funds – T. Rowe Price Small Cap Value (Ticker: PRSVX, down 7.03% for the 12 months ended 4/3/08).

It turns out that in 2007, the fund made one of its largest capital gains distributions in years while effectively finishing the year where it started.

If you made the mistake of buying the fund on December 17 for $39.99, you would have found yourself in a position on December 18 of holding a fund worth $35.40 and a taxable check for $5.16.

Source: Yahoo Finance

$4.85 of the $5.16 was a long term capital gains distribution, taxable at 15% or $.73 per share. $0.73 on $40 is 1.8%, so investors unlucky enough to get in before December 18 were immediately down almost 2 points on their investment.

The balance of the $5.16 was short term capital gains and dividends which have tax rates that can vary, so we’ll set those aside – but you get the point.

Is this situation unusual for mutual fund investors? Unfortunately no. Schurenberg cites Lipper’s Tom Roseen, “The typical fund loses nearly two points of return to taxes on distributions each year.”

For more on mutual funds and taxes, see our prior post The High Cost of Mutual Funds – Part 3.

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