Tax-managed funds are a newer type of mutual fund that attempt to help their shareholders minimize the taxes they pay on the fund. Because dividends and interest earned in mutual funds and capital gains are all passed down to the fund’s shareholders, they are completely taxable to the mutual fund’s investors. The mutual fund itself doesn’t pay the taxes. Therefore, tax-managed funds try to minimize the amount of dividends, interest, and capital gains that are passed down to its shareholders. The funds do this in a number of ways. First, the fund may elect to concentrate on lower-yielding securities.

By choosing investments that aren’t focused on providing current interest and dividend income, the funds won’t wind up passing that income on to their shareholders, who in turn would wind up paying taxes on it. This means that the funds would then be favoring more growth-oriented securities. Second, the funds may try to reduce the distribution of capital gains. They achieve this by adopting a buyand- hold stance on the securities, rather than a buy-and-sell approach. This minimizes the turnover in the underlying securities.

Third, tax-managed funds may elect a tax-efficient selling policy. This means that when the funds sell some of their appreciated securities, they pick the ones that will have long-term capital gains, instead of short-term capital gains. The long-term capital gains tax rates are more favorable than the short-term tax rates. They will also try to pick the securities that have the highest tax base when selling. Often times when selling, the fund will try to offset any gain with a tax loss, which also minimizes the amount of gain that is passed on to the shareholders. These funds may be appropriate for investors who are in higher tax brackets.