Feb. 7, 2003 — The financial community may applaud President Bush’s proposal to end dividend taxation at the individual level, but fund investors still face tax challenges, including capital gains taxes.

Chuck Ritter, manager of American Century Tax Managed Value/Inv (ACTIX), said avoiding capital gains distributions will continue to be the focus of his tax-managed portfolio. He feels the broad market’s current yield — 1.92% for the S&P 500 — offers low levels of income, which actually limits the appeal of dividend-paying stocks. Ritter’s fund fell 13.7% last year, compared with a loss of 20.0% for the average large-cap value fund.

Regardless of any alleviation in the tax on dividends, Kevin Divney, manager of Putnam Tax Smart Equity Fd/A (PATSX), said capital appreciation will continue to be his main goal. Divney said he might consider investing in stocks paying higher dividends, but “that remains to be seen.” Putnam Tax Smart Equity Fund fell 19.1% last year, while the average large-cap growth fund dropped 27.9%.

Capital appreciation is also prime goal of Barry Ogden, manager of Waddell & Reed Tax Managed Equity/A (WMEAX). Like many tax-conscious managers, Ogden focuses on large-cap growth stocks, which tend not to pay dividends. Waddell & Reed Tax Managed Equity Fund lost 16.4% last year, versus a 22.9% decline for the average large-cap blend fund.

Any investment shifts resulting from dividend tax relief will not appear in the short term, said Kermit Eck, manager of Advisors Inner Circle C&B Tax Managed Value Port (CBTAX). Future changes may make the market more efficient in allocating capital, but Eck said he will still emphasize stocks with high returns. Advisors Inner Circle C&B Tax Managed Value fell 7.3% last year, versus a 20.0% decline for the average large-cap value fund.

Maximizing after-tax returns should be an investor’s main goal, said Susan Hirshman, a vice president of planning strategy at JP Morgan. Regardless of any dividend tax changes, Hirshman says capital gains taxes are “still high.”

Though a repeal of the tax on dividends is expected attract more money to the market and fuel returns, many are taking a wait-and-see approach as the plan works its way through Congress and takes a final shape.