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Your funds are in the red. And now Uncle Sam is beating you black and blue. Red, black, and blue. Is it your patriotic duty to lose money and pay taxes for it?
The results are in and they aren't pretty. According to the Investment Company Institute (ICI), mutual funds experienced outflows in August for the first time since 1990 as equities took a beating. Many funds out there are losing money. During the course of a year, funds typically trade in and out of winning and losing positions (some more frequently than others). At some point, a trading fund, even one with a declining price, will realize some winners. But, as we remember from last RI installment, realized gains = capital gains, which = taxes.
Morningstar compiles a monthly list of mutual funds with potential capital gains exposure (the goods aren't on their site, you either have to pay for it or tote a press pass). The figures point out a fund's total assets that represent capital appreciation; essentially the taxable portion of the fund's assets if it liquidated today. "Potential" does not mean much on its own, but when you look at it in conjunction with a fund's turnover ratio, the exposure bears large tax implications.
The turnover ratio reflects the fund manager's activity and compares the volume of trading against the portfolio's value. The ratio is a cumulative number for the entire year. Hence, you can have a turnover ratio greater than 100%.
Regardless, the higher the turnover ratio, the more likely it is that the fund will realize gains - whereby the subsequent capital gains taxes get passed on to the people who actually own the shares (you and me).
Here's the worst five from the September 30 Morningstar release.
Potential Capital Gains Exposure:
| Fund | YTD Return | potential cap gains exposure | Turnover Ratio | Assets (in $m) | NAV (10/14/98) | |
| 1 | DG Opportunity (DGOPX) | -23.49% | 33% | 116% | $89.7m | $9.43 |
| 2 | Chesapeake Agg. Grwth (CPGRX) | -22.52 | 36 | 116 | 506.9 | 12.42 |
| 3 | Kemper Small Cap Equity B (KSCBX) | -21.57 | 30 | 102 | 186.0 | 4.39 |
| 4 | Kemper Small Cap Equity A (KSCAX) | -20.62 | 32 | 102 | 518.3 | 4.67 |
| 5 | WM Emerging Growth B (SQEMX) | -20.15 | 33 | 112 | 28.5 | 12.7 |
What you can do:
If your funds are in a tax sheltered account, such as an IRA, Roth IRA, or 401(k), you don't have much to worry about. However, if your funds are taxable, the capital gains taxes can add insult to injury.
To find out if your fund is at risk, check its turnover ratio (available in any Morningstar "quicktake") and the fund's "Statement of Assets and Liabilities," which is found in the prospectus. If you've lost your snail mail copy, a wide range of online prospectuses are available at Yahoo. With this information you can assess the potential for capital gains taxes.
Take a close look at your funds and their exposure so Uncle Sam doesn't catch you with a surprise left hook this winter.Sign up for our free eNewsletter Dollar Stretcher Tips.
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