How bad is it? Some funds distributed capital gains equaling 20 percent or more of their assets, according to Morningstar. That's on top of losses of 40 percent to 60 percent for the year. In other words, if you placed $100,000 into such a fund a year ago, you could find that the current value of your investment is only $60,000 -- yet you now have a tax bill of $3,600.
This is not the first time investors have experienced such a phenomenon. After tech stocks went bust in 2000, according to Lipper Inc., taxes on fund distributions hit a record $31.3 billion.
This demonstrates the importance of understanding the potential tax burden of investments that incur high turnover -- and considering alternatives. If you're getting hit with a big tax bill on top of horrific returns, perhaps it's time to consider investments with lower turnover. While low-turnover funds are not guaranteed to perform well (no fund is), at least they are less likely to create a high tax burden during times of poor performance.
Investors should consider the investment objectives, risks and charges and expenses of an investment company carefully before investing. This information can be found in the prospectus and should be read carefully before investing.