Conference nyoss1::market_investing

>    But suppose the above shares went to $12 before the distribution,
>    and dropped to $8 after a $4 distribution. Your capital gain is 
>    really $2, but you'll pay tax as if it were $4. Of course, you
>    really have made 20% in the fund as a whole, so life could be
>    worse. 

You pay tax on the distribution as a realized gain.  So in this example
you pay taxes on the $4/share distribution.
    
>    So generally, isn't the hidden gains of a fund something of a
>    liability to the new purchaser, at least if the fund has a habit
>    of turning over the portfolio? The only place I've seen any mention
>    of this is in the Business Week ratings. Some of funds recommended
>    by Money Magazine have big hidden gains. I called one of the funds
>    and asked them about the hidden/unrealized gains, and they couldn't
>    tell me what their ratio was, or how Business Week came up with the
>    numbers they did.

Yes, 'hidden' gains can be a liability.  It is generally better to avoid
purchasing funds which are soon to be making capital gains distributions.
    
>    A more subtle question: if you buy shares at $10 a share, and sell
>    at $10 a share later in the year, before any gains distribution is
>    made, are you liable for any taxes on later distributions by the fund?
>    I would hope not, but...

If you buy at $10, sell at $10, and don't receive any money in the form
of dividends/capital gain distributions/etc. then you don't have any 
gain, and thus have no tax liability.  You still enter the transaction
on Schedule D.

    Morningstar Reports discusses hidden capital gains for each fund it
    covers.
    
    No, you don' have to pay taxes if you sold your shares and therefore
    received no capital gains distribution.
    
    Try looking at the positive side: capital losses.  Harbor International
    Fund NAV increased 45% in 1993, yet almost all of its gains were offset
    by prior years' losses.  Investors who bought Harbor on 1/1/93 got a 
    free ride.

    
    Sounds like one way to protect oneself from paying for somebody 
    else's gains would be to sell the shares before the capital 
    gains distribution occurred. For example, when I called 20th
    Century funds, they said they make their distribution in December.
    So if I sold in November, I'd have only my own gain/loss based
    on share price to deal with. 
    
    BL
    

    I need some clarification of capital gains distributions.
    
    I have a Janus 20 mutual fund (not as IRA),  do I have to claim the
    capital gains distribution on a yearly basis as one would on a CD or do
    you only claim it at redemption time.
    
    I thought I had this down pact but I'm not sure right now.
    
    Thanks
    Frank  

    
    Re: .4, your fund should send you a form saying what capital gains
    distributions, if any, were made. You have to pay tax on the 
    distribution in that year. When you redeem the shares, you
    pay gains on the difference between the purchase and sales
    prices of the shares. The fact that you can get hit with a gains
    tax even if your shares have not risen in value is the issue I raised
    in the base note.
    
    The issue of Kiplinger's on the newstands now has a good article 
    on the tax issues with mutual funds. You especially should note that
    if the captital gains within the fund were re-invested, and on which
    you paid tax, that you don't want to treat that as a gain a second
    time when you redeem the shares.  Good record-keeping is the key.
    
    BL
    
    
    

Many index funds do not have any capital gains distribution -
as long as there is a net cash inflow.

The only distribution are dividends from the funds held in the
index.

Gim

    re: .4
    
    Like .5 said, you receive a 1099-DIV form from your mutual fund company
    each year. If your fund company declaered a dividend, you are liable
    for income tax on that distribution. When the dividend and capital gian
    are decleared, your share price will drop by the same amount. Let's say
    in a situation stated by .5, if your share price did not change through
    out the whole year. And, at the end of the year your fund decleared a
    dividend on your fund. Then, the share prices dropped. You will have to
    pay tax on the dividend decleared. But, if you also sell your shares at
    the "lowered price", you will have a capital loss. That will wash out 
    the dividend gain you had. So, it is a wash at the end.
    
    Mike

    re: .3
    
    I would be careful using the "strategy" you suggested. Mutual fund
    investing is for long term. Usually, your dividend and capital
    distribution is much less than your real gain through out a year. If
    you sell you shares each year, you'll have to pay tax on all of your
    gains. This will deminish the effect of tax deferred (well, sort of)
    compound growth. - You'll have a smaller nest egg to enjoy at the end.
    
    Mike

Re .3:

I would advise against letting tax avoidance take overwhelming precedence in 
your investment tactics.

Let me share with you a real experience ( a "life lesson", the term my wife 
uses with the children).

Near the end of October 1992, I learned of a mutual fund that appeared quite 
attractive.  Even though the distribution date was in December, I made my 
initial purchase anyway.  The fund then proceeded to rocket up in November.
After the distribution date, it went to sleep for six months.  Elsewhere in 
this Notes Conference you will see remarks about how stocks make short, sharp 
gains -- if you are out of the market during these spurts, your performance is 
severely impacted.  If I had waited to make my purchase to "avoid paying tax 
on someone else's capital gains", I would have missed out.

There's more.  In 1993, I made one of my colleagues aware of this same fund.
He dallied for a while; and then when he made up his mind, he decided to wait 
until after the December 1993 distribution date to "avoid paying tax on 
someone else's capital gains".  He was right: the fund did not move between 
then and the distribution date.  He was also wrong: the fund closed to new 
investors.  To rub salt in the wound, the fund then did its one month upward 
spurt in January 1994.

    
    re: .8 -- I agree with you, and wasn't promoting it as an investing
    principle, just an option that's open. If one were going to change
    funds for some reason, the time to do it would be before the 
    distribution rather than after, so as to only be liable for taxes
    on one's own real gains. But clearly if you've picked a fund as 
    a long term investment, the long term effect of hidden gains should
    be small. 
    
    So as a strategy, I would suggest (1) find out when gains distributions
    are made, and (2) what the current hidden gains are, before investing.
    
    Here's an example: 20th Century Heritage makes gains distributions
    in December. Business Week lists their hidden gains at 20%, which
    may or may not be accurate. According to the prospectus, in years
    when the fund has made distributions, it's been under 10% of value.
    But last year was a year of good gains in the stock market, 
    and fears of higher interest might have the fund managers locking in
    the gains on higher-flying stocks. Would it have made sense to
    buy into the fund last December, and pay taxes on 10% of your money
    in the spring of this year? I think I'd wait until January. 
    
    If you later decide you know a better fund to be in, your financial
    situation having perhaps changed, it might make sense to sell
    the fund in November, rather than wait until December and take the 
    possible extra capital gains hit.
    
    BL

Understanding the Intricacies of Tax Liability
   -Kylelane Purcell (reprinted without permission, 5-Star Investor, Sept 1993)

  Tax is an omnipresent aspect of investing, yet it is one of the most difficult
for the individual to plan around.  Very little information currently exists to
help investors asses tax consequences of their investment choices; most data
now available gauges the effect taxes have had on a fund's past returns.  For
these reasons, Morningstar has developed an estimated tax liability figure for
each open-end fund in 5-Star Investor.
   The calculation involved is explained in the revamped User's Guide that 
accompanies this issue (not included here../mtb).  The formula uses as its
starting point realized and unrealized net appreciation (or gains).  Whenever
a fund sells (realizes) a security at a profit, it is required to pass those
gains to its shareholders on a per-share basis, generally by the end of the 
calendar year.  This action--the distribution of realized appreciation--is 
subject to standard capital-gains tax.  Therefore, any capital gains that
have not yet been distributed to shareholders represent a potential near-term
tax liability.
   Unrealized gains are a longer-term tax concern.  As long as a fund does not
sell an issue at a profit, no direct tax burden will be placed on an investor
at year-end.  Yet when an issue that has accumulated much unrealized 
appreciation is finally sold, the tax consequences can be significant.  When
a $10 stock is sold at $100 and the gains are then passed around to shareholders
a full 90% of that distribution is subject to the taxman's axe.
   The Morningstar estimated tax liability formula gauges how much potentially
taxable realized and unrealized appreciation is built into a fund's NAV.  The
final figure listed in the Morningstar 500 is a percentage:  A 40, for example,
means that approximately 40% of the fund's NAV is composed of the realized and 
unrealized appreciation that could eventually subject shareholders to capital-
gains tax.
   Although the estimated tax liability figures provided may appear mysterious,
they generally describe logical relationships.  Funds that buy and sell 
securities frequently and distribute the gains they've made on a regular basis
will have little accumulated gains built into their NAV; therefore, although 
current investors shoulder a tax burden on a regular basis, new investors to the
fund take on only a slight potential burden from past fund activity.  ALGER
SMALL CAPITALIZATION, for example, has posted significant gains since its
inception.  With a turnover greater than 120%, however, the fund has realized
and distributed its gains consistently.  The fund's estimated tax liability for
new investors is therefore quite modest--less than 15%.
   Alternatively, a successful fund with a long-term, buy-and-hold strategy will
have extraordinarily high unrealized capital gains built into its NAV.  An
extreme example is LEXINGTON CORPORATE LEADERS--a fund that holds a static list
of extremely large, well known firms.  The fund almost never changes its port-
folio; therefore, more than 61% of its NAV represents unrealized appreciation--
and a tax liability for new investors, should the fund's holdings be sold.
   While turnover does have a bearing on a fund's estimated tax liability, 
growth gears the engine.  Funds that make capital gains are more likely to 
expose shareholders to captial-gains tax; therefore, few income-oriented bond
investments in the Morningstar 500 post estimated tax liabilities that crack the
double digits.  On the equity side, modest-growth, value-oriented funds 
generally post low tax liabilities; indeed, funds in the Morningstar 500's 
conservative group generally list lower tax liabilities than do the growth-
oriented funds in the core or aggressive sections.
   The combination of high portfolio growth and low turnover generally produces
the greatest potential tax liability for new investors.  Ironically, although
the funds with these qualifications have historically been kindest to the tax
statements of shareholders, they also have let large amounts of unrealized
appreciation build up in their NAV--and thus pose new investors with the
greatest potential future tax threat.  SENTINEL COMMON STOCK, for example, has
been relatively efficient in shielding shareholders from hefty tax burdens over
the past 10 years, yet its current estimated tax liability approaches 42%.
   Negative percentages in the tax liability column represent tax-loss carry-
forwards--the IRS allows funds to balance current fund gains against past fund
losses before the new gains become subject to tax.  A fund listing a -10%, for
example, can allow its portfolio to grow by 10% before new gains become taxed.
Any type of fund can have a tax-loss carryforward; because the equity funds in
the Morningstar 500 are excellent long-term performers, however, only a very
few of them post negatives in this column.  Significant negative figures do show
up in the specialty and short-term bond sections, however:  These reflect the
difficulties experienced by high-yield and international bond funds since 1989.
   The wild card is estimated tax liability is fund asset growth.  Large inflows
of cash into a fund dilute the tax burden incorporated into a fund's NAV; 
likewise, a fund suffering from net asset outflows will experience a sharp rise
in tax liability.  The effect can be slight or significant; either way, it
provides a strong argument for sticking with a fund that has proven appeal for 
investors.
   Rarely does tax liability provide a good first screen for fund shoppers--a
risk-averse investor shouldn't buy aggressive, high-turnover funds simply 
because their tax liability is slightly lower than those of some core funds--yet
it does provide a divining rod once an investor has narrowed the choices to
just a few.  Ultimately, investors must decide whether they prefer a fund that 
frequently exposes them to small tax bites, or take a chance on one whose 
taxable distributions are infrequent but potentially very large.

Investors Should Cage Their Tax Anxieties
     -Michael Penn (reprinted without permission from 5-Star Investor, Jan 1994)

   Investors fear no bogeyman more than the tax collector.  The government lays
claim, after all, to 28% of an investor's capital gains and to as much as
39.6% of the ordinary income produced by a mutual-fund investment.  For a person
in the highest tax bracket, those taxes can wick away 1.9 percentage points
from the annual return of the average equity fund and 2.9 points from the 
average taxable-bond fund's gain.
   Individuals who let fear of taxes keep them from investing, however, end up
paying far more in lost opportunity than they likely ever would in taxes.  
Although tax laws are complex, investors who devote a little time can easily
understand the basics of mutual-fund taxation.  Those who do will learn quickly
that differences in investment objectives and management styles can cause 
funds with like returns to have distinct tax consequences.  By understanding how
a fund's characteristics affect the taxes it will incur, investors can over-
come their fears and instead focus their energy on choosing funds with the 
highest after-tax return.
   As is the case with many fears, anxiety about taxes is at least partially
grounded in misunderstanding.  Tax myths are often bandied about in the
financial press.  Investors have a read a great deal, for example, about the
supposedly onerous taxes levied on capital gains, leading some people to believe
that income-oriented investments such as bond mutual funds that distribute many
capital gains.  Income payouts, however, are taxed at the investor's marginal
income-tax rate, which for an individual with an annual income of more than
$53,500 ( or a couple with an income of more than $89,150) is higher than the
flat 28% capital-gain tax rate.  Thus, for many investors, funds that focus on
growth of capital can carry a lower tax bill than like-returning funds with 
heavy income streams.
   A comparison of the tax profiles of two corporate-bond funds can illustrate
this advantage.  HARBOR BOND and PUTNAM INCOME each have returned nearly 14% a
year over the trailing three years, but the funds have followed quite different
strategies in doing so.  PUTNAM INCOME, whose 8% yield ranks as one of the 
highest in the Morningstar 500, derives much of its return from a steady flow
of income; HARBOR BOND, on the other hand, augments its below-average yield
with capital-gain distributions.  Because the Putnam fund pays more income that
Harbor, and individual in the top marginal income-tax bracket would have paid
6.3% more in taxes over the trailing three years by investing in PUTNAM INCOME
rather than HARBOR BOND.
   Another widely publicized fable about capital-gains taxes is that an
individual who buys a mutual fund shortly before it distributes a capital gain
pays taxes on other people's gains.  This notion assumes that the capital gains
distributed by a fund are a bonus reward fro past gains; thus, a person who
bought a fund the day before it paid out its capital gains would assume a tax
burden he or she would not have otherwise faced.
   A mutual-fund shareholder is almost never liable for taxes on gains enjoyed
by previous investors.  Even if a capital-gains distribution is made the day 
after he or she buys shares, and investor in the end pays no more in taxes than
he or she would have if the distribution were not made.  The reason is that fund
distributions are not extras--they are deducted directly from a fund's asset
base.  Without the distribution, the assets would stay unrealized; eventually,
either after the investor sells shares or receives another distribution, he or
she would face taxes on the gains.
   A capital gain distributed the day after purchase does not necessarily expose
the investor to any tax, because a distribution causes a fund's net asset value
(NAV) to fall by an amount exactly equal to the per-share distribution.  Thus,
following a distribution, the shareholder will experience a per-share capital 
loss (as shown by the drop in the fund's NAV) equal to the per-share capital
gain he or she received from the fund.  If he of she sold the fund on that day,
the net gain--and the tax bill fro this fund--would be zero.
   That's not to say that buying a fund the day before it makes a distribution
poses no tax concerns.  While investors needn't be concerned about incurring
taxes on someone else's gains, they should look carefully at when they incur
taxes on their own gains.  In general, investors benefit by deferring taxes as
far into the future as possible.  That's because fro any given gain, the total
dollar amount of taxes due does not change over time. If, for example, a fund
realizes and distributes a $5 capital gain, an investor would owe 28% (or $1.40)
in taxes.  If, on the other hand, the fund chooses not to realize the capital
gain, an investor would face capital-gains taxes only when he or she sold 
shares.  For shares sold one year later, the tax on that $5 gain would still be
$1.40.  Because inflation erodes the value of money, however, that $1.40 would 
be worth less a year from now than it is today; in real terms, the investor
actually pays a lesser tax in the future.
   Fund distributions force a liquidation of assets, thus making the taxes on 
those assets due immediately.  A distribution made one day after purchase, for
example, presents the shareholder with a tax burden only on day after buying
shares; in a fund that did not make sizable distributions, the shareholder 
would have been able to defer much of that tax years into the future.
   Funds that rarely make large capital-gain distributions allow investors more
control over the timing of their taxes, and thus may be appealing to individuals
concerned with their current tax load.  Such funds enable shareholders to keep 
a large portion of their investments' capital gains unrealized--and thus 
protected from taxes until they choose to sell fund shares.  As mutual funds 
realize capital gains when they sell securities, these funds can often be 
identified by a low portfolio turnover rate.  Such funds will also show much 
greater NAV appreciation than similar-returning funds with higher turnover 
rates, because low-turnover funds have embedded in the NAVs many unrealized
gains.  A good example of this type of fund is an index fund, which by
definition rarely alters its portfolio.  VANGUARD INDEX 500, for example, 
carries a single-digit turnover rate, and for the five years ending November 30,
its NAV has risen to $43.76 from $27.30.  Over the same time period, FOUNDERS 
BLUE CHIP, a fund with an almost identical return but a much more active 
buy-and-sell strategy, saw its NAV climb only to $7.69 from $6.54.
   Funds that meet these criteria, however, should be evaluated with great care.
Because low-turnover funds have made few distributions in the past, any current
captial-gain distributions could be quite large--as evidenced by a large
potential capital-gains exposure figure.  An immediate taxable distribution 
would defeat the main benefit of these funds to an investor who seeks to defer
his or her tax burden.  Therefore, prospective investors should evaluate the
likelihood that the fund may declare a distribution in the near future.  In the
case of an index fund such as VANGUARD INDEX 500, the probability that the
fund would sell of many of its securities and realize capital gains is small.
Other funds, however, may have built up large unrealized capital gains by
making hay of a short-term market run.  SALOMON BROTHERS OPPORTUNITY, for 
example, has ridden the success of financial stocks over the past three years;
those gains are reflected in its potential capital-gains exposure figure of 
48.9%, second-highest among Morningstar 500 equity funds.  Should the future
for financials look bleak, the fund would likely sell many of its holdings at
a high profit, generating significant capital gains.
   The relative importance of putting off capital-gains taxes depends on an
individual's investment horizon.  Investors with a 10-year outlooks may find
low-distribution funds useful, because with such funds, investors can put off
paying the bulk of the capital-gains taxes fro several years.  In the meantime,
they are able to invest the money that would otherwise go to pay annual taxes.
They should also keep in mind, however, that when they do sell shares of such 
funds, their tax bill may be quite large.  For investors with two- or three-year
horizons, deferring tax liability may not be nearly as important--the gain to
be had by putting off taxes only one or two years would be relatively 
insignificant.
   In either case, understanding a fund's potential tax consequences enables
individuals to assume more control over their own tax liability.  By examining
how a fund's approach to making money can affect its tax profile, investors can
begin to evaluate a fund's tax liability as easily as its returns or expenses.
With that knowledge, investors are then able to deal with the subject of taxes
with reason and purpose, instead of fear.


(drop in box)
          **********************************************************
          *          Debunking the Extra-Tax Myth                  *
          *               $ Per Share                              *
          * Fund                         1/15/94 1/16/94 12/31/94  *
          * ------------- ---------------------------------------- *
          * NAV                          20.00   16.00   18.00     *
          * Capital Gain Distributions      --    4.00      --     *
          *                                                        *
          * Shareholder 1                                          *
          * ------------------------------------------------------ *
          * Purchases on 1/15/94 and sells on 1/16/94              *
          *                                                        *
          * Capital gain distributions ($ per share)          4.00 *
          * + Capital gain realized by sale ($16.00-$20.00)  -4.00 *
          * Net capital gain or loss                          0.00 *
          * TOTAL CAPITAL GAINS TAX DUE (Net gain x 28%)      0.00 *
          *                                                        *
          *                                                        *
          * Shareholder 2                                          *
          * ------------------------------------------------------ *
          * Purchases on 1/15/94 and holds until end of year       *
          *                                                        *
          * Capital gain distributions ($ per share)          4.00 *
          * + Capital gain realized by sale ($18.00-$20.00)  -2.00 *
          * Net capital gain or loss                          2.00 *
          * TOTAL CAPITAL GAINS TAX DUE (Net gain x 28%)      0.56 *
          *                                                        *
          * Because a fund's NAV drops when it pays a capital gain,*
          * investors do not face extra taxes on those gains.      *
          **********************************************************