Special market update with major tax implications

For many equity investors, 2018 has felt like riding a roller coaster, with more significant market declines than they’ve experienced in years.

However, we are still in the longest bull equity market (positive gains) in the history of the U.S. stock market.  This may come as a surprise in light of the market’s tumultuous October performance, which was the worst month for U.S. equity returns in nearly seven years. The result of these two seemingly contradictory realities is that investors may be in a precarious situation, including those with positions in mutual funds.

As we have previously written, mutual funds are required by law to distribute at least 98% of their net capital gains (after “netting” out trades with losses and gains) to shareholders once per year. These distributions usually occur in November and December, and will be taxed either as ordinary income or as capital gains income (depending on whether they are short-term or long-term positions). If they are held in tax advantaged accounts, such as an IRA or a 401(k), the distributions are not taxable. The unusual circumstance investors may find themselves in, is that their portfolio may be flat or down for the year, yet they may still face significant income taxes for distributions from their mutual fund holdings. In one example that our team is tracking, we found a fund which is down -14.1% for the year, but partly because of its historical performance, it will still be paying out a distribution of 38.1%, which of course, will be taxable income.

The good news is that this may be entirely preventable. The rough month we experienced in October provided investors with some unique opportunities. With diligent tracking of mutual fund performance, our investment team has been able to identify many instances where tax-loss harvesting can be employed to offset the potential taxes resulting of capital gains distributions.

So, while an investor’s portfolio may be down for the year, there may be opportunities for those losses to become a strategic asset. In addition, funds which are poised to pay distributions can also be sold before those distributions are paid out. What’s required to take advantage of this unique market environment is a dedicated team, and a long-term goals-based investment management approach.

If you have any questions about your portfolio, please reach out to your wealth counselor or a member of our investment team.

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About the Author

Chase Conti, CFP®, CAIA provides due diligence on investment managers, works with financial advisors to construct investment strategies and integrated asset allocations, and oversees all trading activity.

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