Author Topic: Potential Tax Risk of Mutual Fund Investing: "Embedded Gains"  (Read 22867 times)

bacchi

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Re: Potential Tax Risk of Mutual Fund Investing: "Embedded Gains"
« Reply #50 on: November 05, 2015, 10:46:53 AM »
Yes, this would be a problem for someone with multi-millions in the market. There's a tipping point somewhere but let's say it's $10 million. If I had $10M, I'd hire some finance intern twice a year to emulate the S&P 500; better yet, I'd put some in a trust and some in housing credits and some in real estate. For those of us with (or aiming for) $1-2M, it's probably not worth the expense or effort.

adamwoods137

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Re: Potential Tax Risk of Mutual Fund Investing: "Embedded Gains"
« Reply #51 on: November 05, 2015, 10:47:40 AM »
If this is an issue (Interest Compound is making a solid argument that it's not at all), it's minor. Worth knowing about, but not worth using actively managed funds instead as suggested by the article.

[citation needed]

YoungInvestor

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Re: Potential Tax Risk of Mutual Fund Investing: "Embedded Gains"
« Reply #52 on: November 05, 2015, 10:49:32 AM »
Kennon simply stated a potential problem and even stated that it doesn't apply to most people.

He even suggested buying the index yourself in such situations, and called index funds a godsend for the rest of us.

What more do you want? Why are you people so aggressive?

Proud Foot

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Re: Potential Tax Risk of Mutual Fund Investing: "Embedded Gains"
« Reply #53 on: November 05, 2015, 10:58:44 AM »
I think what he says in the article is very good.  And also believe that it does not apply the majority of people.  Obviously if the funds are held within a tax-sheltered account it doesn't have any effect on you at all.  In my opinion the embedded gains is something to be aware of but is also is unlikely to come into effect. 

And if I had the money (winning the lottery like his example) I would do as he suggests, I would purchase the individual stocks to create the index.  Particularly from a buy and hold standpoint. If you followed the S&P 500 and reinvested dividends, I think you could do better than a S&P 500 index fund over the long run.

brooklynguy

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Re: Potential Tax Risk of Mutual Fund Investing: "Embedded Gains"
« Reply #54 on: November 05, 2015, 11:05:58 AM »
When there's a large fund loss, such as in the example ($53-$13), sell the shares, which will counter any distributed LTCG and taxes due. Since distributions at Vanguard are announced ahead of time, this can be done pre ex-div in 2008; or it can be done in 2009, per the example, moving the losses to the 2009 tax return.

In other words, this is easily solved with a little end of year planning.

1) See that Oppenheimer is going to make a large distribution at the end of December.
2) Realize that this will increase personal taxes due to LTCG, even though the market is doing poorly.
3) Look at the fund NAV and see how awful it's doing.
4) TLH the fund, taking a ~$30/share loss.

There's no need for individual stocks or an advisor or a managed fund.

But that forces you to exit the market when you otherwise wouldn't be and may not want to (and, depending on when you bought in, by selling the fund shares, you may not be incurring a loss to harvest, but be realizing a gain), all in order to mitigate the problem of avoiding incurrence of a tax liability on someone else's capital gains.

You can easily TLH exchange from VTSMX into VFINX. Yes, this all takes a little work but so does managing 75-500 individual stocks.

The phrase "someone else's gains" doesn't really fit because the NAV takes care of it. This is more of a "someone else making tax decisions for you" situation. The fund manager can decide to distribute a large amount, forcing a taxable event (that can be a loss or a gain, as you noted). You never actually pay more taxes than what you would pay normally (more or less), which is why I dislike "someone else's gains," but you may pay taxes before you're ready.

Isn't the entire problem in need of mitigation in the first place the incurrence of tax liability on "someone else's" gains?  If you buy fund shares with embedded gains already built-in, and then the fund realizes those gains and distributes them to you, then you're effectively left holding the bag for tax liability on gains that accrued before you bought in (and established your own cost basis), while previous investors in the fund were able to cash out with no responsibility for those (then-unrealized) gains.

In any event, your proposed mitigation strategy is to sell the fund shares once the distribution has been reported but before the distribution occurs, correct?  But if you bought the fund shares (with preexisting embedded gains) at $100, then they subsequently rose to $500, then the market implodes, triggering massive redemption requests and, in turn, forcing the fund to liquidate assets and realize gains, and the fund shares are down to $150 when the distribution is reported, what do you do?  If you sell your fund shares to avoid the distribution, you realize a $50 per-share gain on the sale (not a harvestable loss) at a time when all you wanted to do was stay the course and continue to hold.