Administration October 4, 2002

Tax Efficient Funds Fare Well

April 10, 2002 (PLANSPONSOR.com) - While it may seem counterintuitive to consider so-called 'tax-efficient' funds for your 401(k), there appear to be more advantages to those vehicles than just tax savings.

Reported by

Nevin E. Adams

Even without factoring in the tax benefits a number of funds, whose claim to fame is minimizing investor taxes, have outperformed their peers, according to CBSMarketWatch, citing data from Standard & Poor’s.

For example, according to the report,

in the large-cap growth category, tax-managed portfolios beat the industry average by 6.4 percentage points,
they also held their advantage in the large-cap blend category – by 1.1%, and
among large-cap value funds the tax-advantaged group outpaced their peers by one-tenth of 1%

Capital ‘Gains’

Retail investors are responsible for capital gains taxes on transactions within the funds they hold – which can include paying taxes on gains within funds that actually suffer a net loss for the year. Mutual fund holdings within qualified retirement plans aren’t subject to those taxes, nor are the participants that invest in them.

Fund managers cite two primary reasons for the solid performance of the tax-managed alternatives. First, diversification within the fund that allows managers to match up winners and losers when they practice tax-loss selling, as well as the general benefits of a more diverse body of holdings.

Secondly, their focus on minimizing taxable events, such as buying and selling holdings within the fund, also tends to keep overall portfolio turnover very low – an approach that can pay off in lean markets.