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Mutual Funds For The Tax-Conscious Investor
CNBC.com | December 14, 2010 | 04:31 PM EST

It’s probably too late for investors to trim 2010 taxable distributions generated by their mutual funds , but switching to funds that minimize taxes could come in handy should tax rates rise in the future.

December is typically when funds send shareholders the tax bill for any stocks they’ve sold for a profit and dividend income they’ve paid out.

Tax-managed mutual funds, offered by about a dozen fund firms, are designed to limit these liabilities by taking tax consequences into account when buying and selling stocks. These funds aim to sell stocks at lower, long-term capital gains rates, harvest losses to offset gains, and limit income not taxed at the 15 percent qualified dividend rate.

Judging tax-managed funds by their tax-cost ratio, a statistic used by fund researcher Morningstar to gauge how much a fund gives up in taxes, can help determine if these funds are really doing their jobs.

The 25 tax-managed U.S. stock funds tracked by Morningstar have mostly performed as advertised, giving up an annual average of 0.46 percent of their assets to taxes over the last five years compared to a tax-cost ratio of 0.84 percent for all U.S. stock funds. Tax-managed funds that invest in foreign stocks have been less effective, surrendering more to taxes than the average international stock fund.

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