Selecting Tax Efficient Investments

March 10, 2010

Money-Guy 03-10-2010

Today’s show was spurred by two things: 1) it’s tax time and, therefore, thinking about taxes and tax planning is fresh on most people’s minds, and 2) a letter we received from one of our Premium Subscribers. In the letter, he stated he would like to hear a show on the tax efficiency of mutual funds and how you select a fund that is tax efficient. So, we set out to answer his questions…

You can’t really discuss the tax efficiency of mutual funds without touching on on the tax efficiency of individual stocks and bonds as well as the tax efficiency of Exchange Traded Funds. In the show, we try to explain that all three have different levels of tax efficiency and that each may be more or less tax efficient than the others depending on the current market environment.

As you listen, keep an ear out for the following topics:

  • How do mutual funds, ETFs, and Separately Managed Accounts operate differently?
  • What are embedded losses and embedded gains in mutual funds?
  • How are dividends and capital gains created inside of a mutual fund?
  • What is the Turnover Ratio and how does it affect my investments?

There are two important thoughts that Bo and I share that I want to make sure you don’t miss. First, when trying to design a portfolio that is tax efficient, it is much more important to focus your efforts on the vehicle in which you will hold the investment (i.e. 401K, IRA, Roth, etc.), than the efficiency of the actual investment. The second issue we try to stress is:

“Don’t let the tax tail wag the investment dog…”

This simply means, don’t sacrifice diversification and/or performance to save a little on taxes. Tax planning and tax efficiency  should be a tool to optimize your portfolio, not your overall purpose for investing.

As we wrap up the show, Bo and I share some current events that have happened over the last week. Our purpose in sharing these is simply to get your opinion. We have no doubt that you, our Money-Guy listeners, are the “cream of the crop”, and we truly value your thoughts and ideas surrounding these topics!

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