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Taxes

A third issue is taxes, which can be a real impediment for investors because they give up control with regard to portfolio transactions when they purchase mutual funds. Funds are required to distribute their income and realized capital gains annually, and investors with taxable accounts must pay taxes annually on these distributions.

By and large, mutual funds have not been managed on the basis of sensitivity to investor needs when it comes to taxes. Instead, mutual fund managers are judged and rewarded on the basis of their overall performance, and if they can enhance this performance by more rapid trading of their positions, which can generate taxable distributions for the shareholders, so be it. Thus, the recognition of capital gains, on which shareholders pay taxes, is solely at the discretion of the fund manager. John Bogle has been quoted as saying, “The fund industry has been run with tax blinders on.”[2]

[2] See Jonathan Burton, “Afterglow,” Bloomberg Personal Finance, April 2002, p. 58.


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