Mutually Surprising Tax Hits

So just for example, in the Fidelity fund family, the widely-held Contrafund plans a long-term capital gain distribution of some $5.27 per share. Many of their "Select" funds also plan large distributions, topping out with the Fidelity Select Leisure Fund at $8.57 per share. You get the idea.

Now, remember that a gain is better than a loss, and especially with top federal capital gains tax rates capped at 15%, taxes may be reasonable. But you should do your homework and plan accordingly. Most funds have a tax information Web page (link to Fidelity's here) or you can call the fund manager directly

It's probably too late to do much for the 2006 tax year, but here are some suggestions.

Short term:

• Don't buy any fund at year-end without checking tax status. If you buy before the gain is distributed, the price you pay will include the gain, and you'll pay taxes on the distribution. Effectively, you pay tax on someone else's gain. Check the distribution date with the fund (or call your broker) and buy afterwards.
• Look for losses in your portfolio. If you're alarmed about a declared gain, find another offsetting loss and take it before year-end.

Longer term:

• Select "tax efficient" funds -- as declared in their charter or evidenced by low portfolio turnover. Tax-efficient funds manage so as to minimize your tax impact. See the prospectus or talk to the fund advisor. Check the percentage turnover rate. If it's more than 20% to 30%, you're susceptible to more taxes in a taxable account.
• Avoid actively managed funds in taxable accounts. Look into Exchange Traded Funds (ETFs) or index funds; these funds buy and sell securities usually only when index components change, minimizing tax exposure.

Remember, while today's capital gains taxes are moderate, even a small "take" from your portfolio every year can derail the compounding train. A sum of $10,000 invested for 20 years grows to $32,000 at 6% annually but only $18,000 at 5% -- so the tax bite is worth avoiding.

Warren Buffett is famous for never selling anything -- and maybe your mutual fund shouldn't either. But if it does, be aware of the consequences.