Mutual funds taxed at a higher rate.....am I on crack???

[yelrach11]

My girlfriend and I have a difference of opinion.....or more so her old man and me do. 

Claim was made by Fidelity guy to her dad that investing in mutual funds in taxable accounts is bad.  The are charged at a higher tax rate then individual stocks.  Totally perplexed as to this position.  Is he relating this to somehow day trading mutual funds and only keeping them in the short term??  Im a buy and hold guy and need some ammo for the next family dinner as my investing strategy feels under attack.


Am I on crack??

Yel

[Heckler]

they definitely have higher fees...

[Frankies Girl]

The answer? It depends, but probably your girlfriend's dad (at least his adviser) is probably right in general...

From Fid's website:
https://www.fidelity.com/learning-center/investment-products/etf/etfs-tax-efficiency

In essence, there are – in the parlance of tax professionals – fewer “taxable events” in a conventional ETF structure than in a mutual fund. Here’s why:

A mutual fund manager must constantly re-balance the fund by selling securities to accommodate shareholder redemptions or to re-allocate assets. The sale of securities within the mutual fund portfolio creates capital gains for the shareholders, even for shareholders who may have an unrealized loss on the overall mutual fund investment.

In contrast, an ETF manager accommodates investment inflows and outflows by creating or redeeming “creation units,” which are baskets of assets that approximate the entirety of the ETF investment exposure. As a result, the investor usually is not exposed to capital gains on any individual security in the underlying structure.

To be fair to mutual funds, managers take advantage of carrying capital losses from prior years, tax-loss harvesting, and other tax mitigation strategies to diminish the import of annual capital gains taxes. In addition, index mutual funds are far more tax efficient than actively managed funds because of lower turnover.

So if you are comparing an actively managed mutual fund to an ETF, chances are it will be a bit higher cost in terms of taxes. But that's just because of the constant rebalancing. But look at the last sentence (bolded) - if you have a passive index fund mutual fund (like Fido's Spartan Total Stock Market Index Fund:  FSTVX) with extremely low turnover and no "active" managers mucking about in the fund... and you're going to at least match the ETF version.


In taxable accounts, you want low turnover and few dividend payouts - those both create taxable events. Therefore, you keep those types of mutual funds out of a taxable if you can help it... things like bonds, REITs, active managed stock mutual funds... all create higher amounts of taxable events. Those belong in your IRA/401k/Roth/403b (tax deferred accounts). Holding ETFs, or passive/low turnover mutual funds are best for taxable brokerage accounts. So they're wrong in that not all mutual funds are bad in taxable, but most folks (not counting the ones on here and other sites like Bogleheads) don't hold passive index mutual funds in their accounts at all...

Check out this bogleheads link on tax efficient placement: http://www.bogleheads.org/wiki/Principles_of_tax-efficient_fund_placement

[MDM]

Claim was made [mutual funds] are charged at a higher tax rate then individual stocks.

need some ammo for the next family dinner as my investing strategy feels under attack.

Put the onus back on the other side.  E.g., something such as
"On form 1040, schedule D, etc. the treatment of qualified dividends and long term capital gains is identical, regardless of whether those come from mutual funds or individual stocks.  Under what scenario do you see the higher tax rate for mutual funds?"

Too many possible assumptions involved to be definitive, but under the assumptions that both have the same amount of qualified dividends and long term capital gains the tax treatment is identical.

[forummm]

The only possible difference I can think of is that maybe your mutual funds have some non-qualified dividends (say if they hold foreign stocks) and the individual stocks in question are all 100% qualified dividend stocks (say most domestic stocks).

But that's not an apples to apples comparison.

[Scandium]

Regardless of which is more tax efficient, the claim made was that they are charged at different rates. Which is blatantly untrue. I agree with MDM; ask to see where on the tax form you check whether dividends are from stocks or mutual funds..

[YoungInvestor]

Regardless of which is more tax efficient, the claim made was that they are charged at different rates. Which is blatantly untrue. I agree with MDM; ask to see where on the tax form you check whether dividends are from stocks or mutual funds..

We're dealing with an adviser said to step-dad said to op who then wrote the topic. Getting bogged down on specific words is pointless, and the meaning is quite clear.

The first reply makes sense to me, and seems to address the intended meaning of the original claim.

[Scandium]

Regardless of which is more tax efficient, the claim made was that they are charged at different rates. Which is blatantly untrue. I agree with MDM; ask to see where on the tax form you check whether dividends are from stocks or mutual funds..

We're dealing with an adviser said to step-dad said to op who then wrote the topic. Getting bogged down on specific words is pointless, and the meaning is quite clear.

The first reply makes sense to me, and seems to address the intended meaning of the original claim.

You mean what Frankies girl wrote? That talks about active funds vs ETFs. That doesn't address the subject at all. The OP vs father-in-law discussion was index funds vs individual stocks. For which the tax rate is the same. It's possible to pick stocks that yield less tax, no dividends for example, but the loss of diversification is not worth it. 

[forummm]

Regardless of which is more tax efficient, the claim made was that they are charged at different rates. Which is blatantly untrue. I agree with MDM; ask to see where on the tax form you check whether dividends are from stocks or mutual funds..

We're dealing with an adviser said to step-dad said to op who then wrote the topic. Getting bogged down on specific words is pointless, and the meaning is quite clear.

The first reply makes sense to me, and seems to address the intended meaning of the original claim.

You mean what Frankies girl wrote? That talks about active funds vs ETFs. That doesn't address the subject at all. The OP vs father-in-law discussion was index funds vs individual stocks. For which the tax rate is the same. It's possible to pick stocks that yield less tax, no dividends for example, but the loss of diversification is not worth it. 

That's not less tax--it's delayed tax. The tax rate is the same.

[Scandium]

Regardless of which is more tax efficient, the claim made was that they are charged at different rates. Which is blatantly untrue. I agree with MDM; ask to see where on the tax form you check whether dividends are from stocks or mutual funds..

We're dealing with an adviser said to step-dad said to op who then wrote the topic. Getting bogged down on specific words is pointless, and the meaning is quite clear.

The first reply makes sense to me, and seems to address the intended meaning of the original claim.

You mean what Frankies girl wrote? That talks about active funds vs ETFs. That doesn't address the subject at all. The OP vs father-in-law discussion was index funds vs individual stocks. For which the tax rate is the same. It's possible to pick stocks that yield less tax, no dividends for example, but the loss of diversification is not worth it. 

That's not less tax--it's delayed tax. The tax rate is the same.

ah yes this is of course true in the grand scheme. So I think we can say that in no way do individual stocks result in lower tax. Not a lower rate, and not less tax. Hurray we win. Go forth and conquer

[seattlecyclone]

If you buy and hold stocks X, Y, and Z, you will be taxed exactly the same as if you owned a mutual fund that buys and holds stocks X, Y, and Z. Actively-managed funds do commonly have "capital gains distributions" that you have to pay tax on, precisely because they're not buying and holding. However the idea behind these is that you'll pay the same amount of tax by holding the mutual fund as you would if you personally owned the same stocks and made the same trades.

[Frankies Girl]

Yeah, I was discussing where the dad/adviser got the idea that ETF are somehow better tax-wise...because it is the boilerplate stuff directly from Fido's site. But because they're not comparing index mutual funds, it is kind of misleading (which was the point I was trying to make). Making a blanket statement that ETFs are always more efficient seems silly, but I think in certain instances it may be true, like when comparing highly traded "active" funds (who does this in a taxable? oh, right, people that pay advisers to manage their stuff)... but definitely not when it came to index mutual funds.

You mean what Frankies girl wrote? That talks about active funds vs ETFs. That doesn't address the subject at all. The OP vs father-in-law discussion was index funds vs individual stocks. For which the tax rate is the same. It's possible to pick stocks that yield less tax, no dividends for example, but the loss of diversification is not worth it. 

To be fair, the OP never said it was a comparison of index mutual funds vs ETFs... just "mutual funds" and ETFs. Mutual funds can be indexed funds, but not all mutual funds are (most aren't actually). So yes, I assumed that they were discussing actively managed mutual funds, and that is probably what the dad (as told to him by his adviser, he's just drinking the koolaid) is meaning.



And if I got anything wrong, y'all feel free to correct me so the OP isn't misled. I am still relatively new at investing (just a few years into this).

[Scandium]

Yeah, I was discussing where the dad/adviser got the idea that ETF are somehow better...because it is the boilerplate stuff directly from Fido's site. But because they're not comparing index mutual funds, it is kind of misleading (which was the point I was trying to make). Making a blanket statement that ETFs are always more efficient seems silly, but I think in certain instances it may be true, like when comparing highly traded "active" funds (who does this in a taxable? oh, right, people that pay advisers to manage their stuff)... but definitely not when it came to index mutual funds.

You mean what Frankies girl wrote? That talks about active funds vs ETFs. That doesn't address the subject at all. The OP vs father-in-law discussion was index funds vs individual stocks. For which the tax rate is the same. It's possible to pick stocks that yield less tax, no dividends for example, but the loss of diversification is not worth it. 

To be fair, the OP never said it was a comparison of index mutual funds vs ETFs... just "mutual funds" and ETFs. Mutual funds can be indexed funds, but not all mutual funds are (most aren't actually). So yes, I assumed that they were discussing actively managed mutual funds, and that is probably what the dad (as told to him by his adviser, he's just drinking the koolaid) is meaning.



And if I got anything wrong, y'all feel free to correct me so the OP isn't misled. I am still relatively new at investing (just a few years into this).

From what I read they were comparing the OP's investment strategy, which I assumed was index funds (since he/she is on this site..) and individual stocks (i.e. shares of coke, apple etc) . Not ETFs. Yes I believe ETFs can be slightly more tax efficient than mutual funds, as they don't have to liquidate when someone sells.

[forummm]

Yeah, I was discussing where the dad/adviser got the idea that ETF are somehow better...because it is the boilerplate stuff directly from Fido's site. But because they're not comparing index mutual funds, it is kind of misleading (which was the point I was trying to make). Making a blanket statement that ETFs are always more efficient seems silly, but I think in certain instances it may be true, like when comparing highly traded "active" funds (who does this in a taxable? oh, right, people that pay advisers to manage their stuff)... but definitely not when it came to index mutual funds.

You mean what Frankies girl wrote? That talks about active funds vs ETFs. That doesn't address the subject at all. The OP vs father-in-law discussion was index funds vs individual stocks. For which the tax rate is the same. It's possible to pick stocks that yield less tax, no dividends for example, but the loss of diversification is not worth it. 

To be fair, the OP never said it was a comparison of index mutual funds vs ETFs... just "mutual funds" and ETFs. Mutual funds can be indexed funds, but not all mutual funds are (most aren't actually). So yes, I assumed that they were discussing actively managed mutual funds, and that is probably what the dad (as told to him by his adviser, he's just drinking the koolaid) is meaning.



And if I got anything wrong, y'all feel free to correct me so the OP isn't misled. I am still relatively new at investing (just a few years into this).

From what I read they were comparing the OP's investment strategy, which I assumed was index funds (since he/she is on this site..) and individual stocks (i.e. shares of coke, apple etc) . Not ETFs. Yes I believe ETFs can be slightly more tax efficient than mutual funds, as they don't have to liquidate when someone sells.

So tax efficiency is not at all the same as tax rate. But assuming that's what was meant. What the Fido rep was really saying is that Fidelity's mutual funds are less tax efficient than ETFs because Fidelity's mutual funds distribute the occasional CG. Of course if you just have your money in one of the Vanguard funds that doesn't distribute any CGs then this point is also moo. (https://www.youtube.com/watch?v=YIkJ4BUChxI)