Taxes in mutual funds are bound to become a bigger and bigger issue as the government faces its deficit. Here is a basic investment tip you can pass along to help your clients keep their tax bill as low as possible:

Make sure that investments that generate a lot of short term gains and ordinary income are in tax protected vehicles whenever possible.

Those kinds of investments include REIT’s, commodity ETF’s (like gold ETF’s), and mutual funds with high turnover. If you need help determining the turnover on a particular mutual fund, just give my office a call and I can email you a report with the fund’s turnover at no cost.

According to a study by Joel Dickson and John Shoven, “Taxes and Mutual Funds: An Investor Perspective” as much as a quarter of a mutual fund investor’s annual returns are consumed by the taxes payable on dividend and capital gain distributions (often the result of high turnover). Over time, the compounding effects of an equity return being reduced by one-quarter are truly dramatic.

For easy math, let’s say the average return of an equity fund is 10%. Over thirty years, with 10% annual returns, $10,000 will compound to nearly $175,000. At 7.5% (factoring in the reduction of one-quarter), it will compound to $87,500—almost exactly half the amount. Yikes!

It pays for you to mind your investment p’s and q’s!