Caveat Emptor: You May Owe Taxes Despite 401(K) Losses!

One among many ways you lose money in non-indexed mutual funds is the tax trap. You may have to pay taxes even when your mutual fund loses money! To many people this is painfully unexpected. Here is how this counter intuitive event occurs. By law, mutual funds do not pay taxes. Instead, they pass on those taxes to you, the shareholder in the mutual fund. If the fund manager sells a stock for more than it cost the fund a profit is generated. This profit is called a capital gain and it is taxable. Capital gains are taxed at your ordinary income tax rate which is between 28% and 38.6% for most investors if the fund held the stock for less than a year. If the stock was held for more than a year, in other words long term, the tax is 20%.

There are a couple of reasons why mutual funds pay taxes. If the fund does poorly investors will bail out. The mutual fund has to sell off stock to pay the investors who leave. Even if you are not one of the investors jumping ship you will still have to pay your portion of the capital gains tax.

Dividends are another reason that taxes come due. Dividends are taxed at the per-share earnings distributions that companies make out of their quarterly earnings. Many investors instruct their mutual fund to automatically reinvest their dividends. This means that the fund uses the money to buy more shares in your name. Even if you reinvest and never get a penny of the dividends, they are subject to tax, according to the IRS.

Another reason you may get a tax bill is due to high turnover. Turnover measures the frequency with which a fund manger buys and sells shares, sometimes in search of the next high-flying stock or undervalued stock on the verge of taking off. According to Lipper, the average fund in 2000 showed a turnover rate of 122%. This means that the entire portfolio changed between January and December, and 22% of the replacement shares changed as well.

This is the ultimate case of account churning! You simply have to understand that when you buy into a fund you are buying into a tax liability. The best way to avoid these taxes altogether is to restrict your purchases of mutual funds to your 401(k) and try to only buy indexed mutual funds such as the Vanguard 500 (FINX).

ABOUT THE AUTHOR: Dr. Scott Brown, Ph.D., a.k.a. "The Wallet Doctor", is a successful futures trader, real estate investor, and stock investor. Dr. Brown holds a Ph.D. in finance from the University of South Carolina. His 1998 articles in Technical Analysis of Stocks and Commodities were prophetic in predicting an impending stock market crash. He has helped many people become profitable investors by teaching them to look out over many years to spot stocks that are low and primed for rise in the new bull market. His second article met with approval by Dr. Bob Shiller of Yale University. Dr. Shiller is the economist that Alan Greenspan most highly regards who coined the term "Irrational Exuberance." In 1998 he shouted to the world to "get out" of the stock market but now he is shouting to everyone that it is time to "get in!" The Wallet Doctor is not only sought after for investment advice and coaching in stock investing but also in futures trading and real estate investing. Visit Dr. Brown's site at http://www.BonanzaBase.com or sign up for his investment tips at http://www.WalletDoctor.com

---

Stocks: Reduce Risk Yet Maximize Profits

It is important to note that every smart investor wants... Read More

Find Your Investing Soulmate on the Jersey Turnpike

As a followup to a previous column, "Irreconcilable Differences," I... Read More

Economic Survival in the 21st Century - the Three Key Questions to Ask

In this "special report", I want to pose a few... Read More

The Dreaded Direct Question

(Please have a glass of water within reach before reading... Read More

Getting Started Investing is Often the Hardest Part

There are several reasons people give for not investing their... Read More

Diversify!

The best way to avoid being hit hard by a... Read More

Investing Psychology Today Requires All Traders to Awaken Their Speculator Minds

Stock trading strategies are as rampant today, as they were... Read More

Chinas Great Missed Opportunity

While a U.S. Representative to the Asian Development Bank Executive... Read More

Gold; What Type of Gold to Buy

JewelryThe advantages are:? Gold Jewelry is the easiest of the... Read More

The Economy Is Not The Stock Market

Several days ago, the Commerce Department reported that May's factory... Read More

Trading Baskets Part I

Q. What is a basket?A basket is a group of... Read More

Just Say NO to Your Stock Broker

We have all heard that slogan that started back when... Read More

For Entrepreneurs A SIMPLE Plan May Be Best

Q: I own a small decorating business and I'll be... Read More

Investing: The Art Of Making Your Money Work For You

There is a lot to know about investing. It all... Read More

A Gadfly On A Dinosaurs Butt, Or The Hood-winking Of The American Investor

Have you ever noticed how some words in the English... Read More

How to Analyze the Veracity of Investment Newsletters

When trying to analyze whether a promotional ad for an... Read More

Why You Need To Buy and Sell Gold Coins (Part 2)

How to Collect Rare Coins For Fun and ProfitTime has... Read More

Advice for International Investors on How to Safeguard Their Profits

What are the risks?Today, investors are increasingly turning to global... Read More

How to Terror-Proof Your Money

"To drift is to be in hell, to be in... Read More

Franchise Investing, Franchise Opportunities and Franchising Renewals

Have you considered buying a franchise instead of trying to... Read More

Asset Allocation: Critical to Your Investment Success

Asset allocation is a critical component of investing success. Both... Read More

Useful Tips on Investing

Here are some useful tips on investing. When you make... Read More

Realistic Investing Expectations

Over the long term stocks have provided us with great... Read More

The Biggest Oil Opportunity in the World ? And How You Can Profit From It

Where is the second biggest deposit of oil reserves in... Read More

It Is Never Too Early To Start A Roth IRA!

The Roth is kind of weird until you get used... Read More

Mutual Fund Returns May Not Be As They Seem!

Arthur Levitt, during his tenure at the SEC, experienced many... Read More

Playing With Money - And Making More

Ready to start playing with your money? Not interested in... Read More

Investor Guide to Financial Health

Step 1: Spend less than you earnPerhaps the simplest financial... Read More

Trading Commodity Futures Using Support and Resistance - Paper Trading

Setting Up a Paper Trading AccountQuestion: I cannot trade with... Read More

Real Estate Clubs Hot Among Investors

Six or seven years ago, the stock market was booming,... Read More

California Deparment of Corporations and Franchise Opportunities Law

What CA Needs To Do To Address Issues in FranchisingWe... Read More

The Economys Greatest Depression Downturn Ever Is Now Just A Few Years Away

What really controls the economy? Forget interest rates, forget deficits,... Read More

Brain Snappers and Other Wall Street Nonsense

The last time you spoke with your broker did he... Read More