Very-Low-Turnover Stock Funds and Tax-Managed Mutual Funds

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Very-Low-Turnover Stock Funds and Tax-Managed Mutual Funds

Financial pros argue that low-turnover funds (funds that don’t trade very often) are generally more tax efficient than high-turnover funds. That’s something of a myth. Morningstar has found that there’s no one-to-one relationship between a fund’s turnover rate and its tax efficiency. In fact, a fund with a 200% turnover rate can be just as tax efficient as a fund with a 50% turnover rate.

Except in certain conditions

However, it found that funds with exceptionally low turnover rates—below 20%—do tend to be tax efficient. Large-company index funds are tax friendly, for example, because they usually carry single-digit turnover ratios.

Tax-managed mutual funds

Tax-managed funds are dedicated to limiting shareholders’ tax burdens. They use a variety of strategies—not just one—to minimize taxes. For starters, they avoid dividend-paying stocks. They also strive to limit capital gains by holding their securities for a long time or by selling losing stocks to reduce their taxable gains.

Tax-conscious investors have a slew of these funds from which to choose. They can be hybrid funds that own both stocks and bonds, large-company funds, small-company funds, and foreign funds. In short, you could assemble a tax-friendly portfolio that invests in a variety of securities.