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7. Investing in Mutual Funds > The Taxman Cometh for Your Fund Returns

The Taxman Cometh for Your Fund Returns

Although taxes can chew through your mutual fund returns when you invest in a taxable account, the new tax law of 2003 can trim your tax bill.

The 2003 tax law is Washington’s gift to the long-term investor, offering substantial cuts in the tax rates on both capital gains and dividends. For investors using taxable accounts, buying and holding makes more sense than ever before. Because distributions of capital gains and dividends are taxable in these accounts, you must pay taxes on all of your distributions, whether you receive them in cash or reinvest them in fund shares. Paying taxes on distributions can cost you 2 to 3 percentage points of return each year. To make matters worse, when you reinvest mutual fund distributions, you must come up with cash from somewhere else to pay the taxes on those distributions on April 15. However, if you buy shares in tax-efficient funds to begin with, and then ch....


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