The market fell on Friday amid concerns of an escalating trade war with China, and the continuing government shutdown. The lack of the monthly jobs report from the Bureau of Labor Statistics, and the delay of expected inflation data are adding to the uncertainty. But before you panic and sell, remember that, at some point, the government will reopen. And companies are still selling goods and services. The market typically rallies when the government is finally funded. Plus, the S&P 500 is up over 11% year-to-date, even with Friday’s decline.
The Securities and Exchange Commission also made a ruling that will have huge implications for how mutual funds are taxed moving forward. Some background may be helpful to understand the ruling.
First, mutual funds are taxed three ways: when the fund receives dividends or interest income, that income is passed along to shareholders for tax purposes. When you sell your shares in the fund, you pay taxes on the gains. And when a manager sells a holding, any gain or loss is passed along to shareholders in the fund at the record date, usually in December. Which means that, if a manager sold a bunch of stock in a given year, perhaps because people were selling the fund, the taxes on those gains in the fund are paid by everyone who didn’t sell. This is how you can have a negative year, when your account value is down, and still have a big tax bill.
Vanguard patented a multi-share class structure that avoids this last tax hit, and that patent expired in 2023. Since then, almost every major money manager has asked the SEC to allow them to do the same thing. The design allows a single mutual fund to have ETF, or Exchange-Traded Fund, share classes along with traditional mutual fund share classes. When a shareholder wants to redeem, or sell, their shares, the mutual fund exchanges the mutual fund shares for ETF shares in what is known as a like-kind exchange. Any embedded capital gains transfer along with the holdings to the new share class. And when the shares are sold, that owner pays any taxes, not whoever is left in the fund on the record date.
Not every fund will offer this, and each company will still have to receive their own ruling from the SEC. There are also operational problems to resolve. In the long run, investors could see reduced fees and taxes as a result.
The impact of taxes on your portfolio should always be a part of your financial considerations. The choice of the investment vehicle itself, tax location, or what type of account you use to hold different assets, daily tax loss harvesting, and Roth conversions in retirement are all important discussions to have with your advisor.
Your action item this week is to schedule your fall HVAC service. And if you haven’t changed the filter for your system in a while, do that as well.
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CovingtonAlsina is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.