With the recently passed tax law, millions of Americans will get some relief. A big change will be in the brackets.
Yet when it comes to mutual fund investments, there will certainly be nagging issues with taxes. One is the end-of-the-year capital gains distribution, which can be an unpleasant surprise. You’ll likely owe taxes on these amounts, even if you reinvest the money back into more shares.
But there is something else to keep in mind: dividends can also mean paying more taxes. This is why some investors prefer investing in growth stocks, which often have little or no yields.
Now it’s true that there are ways to shelter your investments, such as with 401k’s, 403b’s, IRAs, Health Savings Accounts and 529s. But there are limits on these vehicles, like caps on contributions and phaseouts based on income.
So, when looking at mutual funds to invest in, it’s important to keep an eye on the potential tax impact. And yes, there are some that are particularly good at providing more protection.
Let’s take a look at five:
Expense Ratio: 0.15%, or $15 annually per $10,000 invested
The Vanguard Total Stock Market Index Fund Investor Shares (MUTF:VTSMX) fund is certainly popular, with a whopping $657 billion in assets under management. A key is that the fund has a low expense ratio of 0.15%. In other words, this means more of the gains go into the pockets of investors.
The VTSMX fund is also highly diversified. There are over 3,600 stocks in the portfolio, which include blue chips like Microsoft Corporation (NASDAQ:MSFT), Johnson & Johnson (NYSE:JNJ) and JPMorgan Chase & Co. (NYSE:JPM).
But of course, the VTSMX offering is also a top contender for tax saving mutual funds. Consider that the turnover is a mere 4%. This is because index funds usually do not involve lots of changes to the overall portfolio.
But isn’t there a dividend yield on the VTSMX fund? This is true. But it is a modest 1.7%. A main reason for this is that there are a large number of small- and medium-cap stocks in the fund.
Expense Ratio: 0.79%
When it comes to tax saving mutual funds, a good place to look is for those that focus on tax-exempt municipal bonds. These are securities whose interest is sheltered from federal taxes. Oh, and if the bonds are issued from your resident state, then this interest is exempt too!
It’s a pretty good deal. What’s more, there are many funds to choose from. And one of the standouts is the T. Rowe Price Tax-Free High Yield Fund (MUTF:PRFHX), which has a strong management team (the minimum tenure is 16 years or so).
While the focus is on lower rated securities, the strategy has been able to produce solid returns – without too much volatility. For example, the management team has strict requirements in evaluating risks, which has meant avoiding problems like Puerto Rican bonds.
Currently the fund has an expense ratio of 0.79% and a yield of 3.7%.
Expense Ratio: 0.17%
Foreign funds can provide diversification as well as access to interesting growth opportunities. But there is a downside: The tax implications are usually not so favorable. For the most part, a foreign fund has higher than normal turnover.
But there are still some exceptions — such as the Vanguard Developed Markets Index Fund Investor Shares (MUTF:VDVIX) fund, which has $104 billion in assets under management. Much of the portfolio is concentrated in larger companies in Europe and Asia. Some of the top holdings include Nestle SA (ADR) (OTCMKTS:NSRGY), HSBC Holdings plc (ADR) (NYSE:HSBC) and Novartis AG (ADR) (NYSE:NVS).
As for the turnover ratio, it is at a reasonable 11%. In fact, the Vanguard Tax-Managed International Fund was merged into the VDVIX fund.
Expense Ratio: 0.09%
Vanguard actually has several funds where the mandate is on tax savings. Just look at the Vanguard Tax-Managed Capital Appreciation Fund Admiral Shares (MUTF:VTCLX) fund, which has $9.1 billion in assets under management.
The portfolio is based on the Russell Index (the index includes U.S.-based small- and medium-sized companies). However, the money managers have the mandate to make adjustments for dividend levels and other tax factors, such as taking advantage of losses.
Consider that the turnover is at 8% and the expense ratio is at 0.09%. Interestingly, since the fund was launched in 2001, there has never been a capital gains distribution.
Expense Ratio: 0.09%
The Vanguard Tax-Managed Balanced Fund Admiral Shares (MUTF:VTMFX) fund has roughly half of the portfolio in mid-and-large cap U.S. stocks and the rest in tax exempt municipal bonds. As for the equity portion, the managers make tweaks to minimize the impact of the dividends. This structure is certainly unique, and definitely attractive for investors in higher tax brackets.
The turnover ratio on the VTMFX fund is 11% and the expenses are 0.09% of the assets. As for some of the top holdings, they include quality names like Exxon Mobil Corporation (NYSE:XOM), Facebook Inc (NASDAQ:FB) and Home Depot Inc (NYSE:HD).
Tom Taulli is the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.