Mutual Fund Tax Crisis

Mutual funds make a taxable distribution at year end of their profits from their “realized” capital gains. During the top of the market cycle mutual funds may have large amounts of low basis appreciated stock and when a crash comes then investors redeem their mutual fund shares, forcing the fund to sell appreciated stocks which triggers a taxable distribution. So when a bubble top bursts then the stocks held by a mutual fund go down and at the same time capital gains taxes maybe incurred. If an investor recently bought a mutual fund at the top of the market and refuses to sell then he will get stuck with the tax bill for gains that someone else enjoyed and he will see his shares go down in value – thus he loses twice! It is urgent because of the coming crash of 2013 or late 2012 for investors to sell equity mutual funds now both for tax purposes and to protect against stock values going down. If you own bonds, assuming my forecast is correct, bonds will go up when stocks go down, so bond investors who use bond mutual funds will not have this problem during the coming stock crash. (Of course in a few years bonds may crash, so don’t hold them forever).

This tax problem makes it important to avoid owning overpriced equities during a bubble top. Always consider selling perfectly good equities if their market price is artificially high and then buy them back during a crash.

The good news is that this is not a tax problem for retirement accounts, it is only a concern for taxable accounts. Your 401k won't incur this tax problem, however 401k's will be hurt because of the downward pressure on stocks prices which will be made worse because of the actions of investors (who have assets in taxable accounts) running for the fire escape.

Investors should seek independent financial advice.

About the author

Don Martin, CFP®

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  • Nice content. It’s always great to read financial advice and tips through quality content. I have already bookmarked the page for future reading. Thanks for sharing.

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