Advisors searching for low tax investment vehicles for their clients’ taxable accounts need to look beyond ETFs, according to Frank Pape, director of consulting services for Russell Investments and a CPA.
Although ETFs are more tax efficient than actively managed mutual funds, they lose more dollars to taxes than tax-managed funds, says Pape, who spoke at Envestnet’s recent Advisor Summit in Grapevine, Texas.
“It’s after-tax returns that make the difference,” said Pape.
Over the five years ended March 31, the average actively managed U.S. large-cap mutual fund lost 1.5% annually to federal taxes among investors in the top marginal tax bracket (43.4%, which includes the Affordable Care Act surtax), while the average passively managed index fund or ETF lost 0.95%, based on Morningstar data, said Pape. In comparison, the firm’s tax-managed U.S. Large Cap Fund lost just 0.38%.
The average actively managed U.S. small-cap fund lost 1.74% to taxes for the highest taxed investors while passively managed funds lost 0.87%; the tax-managed mid- and small-cap fund lost 0.73%.
“Left unmanaged, a hidden tax expense of funds can be more than the fee an advisor is charging his or her client,” says Pape.
In addition to Russell Investments, many other fund companies offer tax-managed funds including Vanguard, Fidelity, Eaton Vance and Bernstein.