Taxation and Mutual Funds: An Investor Perspective

Shareholder level taxes are taken into account in determining the performance of growth and growth and income mutual funds over the 1963–1992 period. We rank a sample of funds on a before- and after-tax basis for investors in different income classes facing various investment horizons. The differences between the relative rankings of funds on a before- and after-tax basis are dramatic, especially for middle- and high-income investors. For instance, one fund that ranks in the 19th percentile on a pretax basis ranks in the 63rd percentile for an upper-income, taxable investor. We also present an analysis of the extra taxes that shareholders bear because of the failure of mutual funds to manage their realized capital gains in such a way as to permit a substantial deferral of taxes. While it is not possible to determine precisely this magnitude, the extra taxes almost certainly amounted to more than $1 billion in 1993.