How Tax-efficient Is Your Mutual Fund Portfolio?

Physician's Money Digest, August 2005, Volume 12, Issue 12

An important long-term consideration when assemblinga mutual fund portfolio is the tax-efficiency ofthe mutual funds. According to Bruce Fenton, founderand president of Atlantic Financial Inc, due to the hightax bracket physicians are in it's important to payattention to the tax efficiency of their mutual fundand integrate it into an overall long-term tax plan."It's probably one of the most important things thatwe look at now," Fenton says.

The considerations are 2-fold: the actual tax efficiencyof the fund and the tax efficiency of the vehiclethe fund is in. If the latter is an IRA, it doesn't bodewell for physicians because the money is going to betaxed as ordinary income when taken out.

"The historical average top bracket for the last 75years is over 66%, and people don't realize that," Fentonsays. "It's only since Ronald Reagan that we've had 50%or below as our top bracket. And in the 1950s, therewere 9 years where the top bracket was 91%. So if youearned $200,000 in 1954, you paid $182,000 in taxes, andthat is significant."

Fenton states that America runs the risk of returningto the tax brackets of the 1950s, particularly becausethere's going to be 70 million people reaching retirementage. "As these baby boomers reach retirement agethey're going to draw from the system—from SocialSecurity, Medicare, Medicaid—and they're not payingtaxes anymore. So will the taxes be higher or lower thanaverage? There's a good chance they'll be higher thanaverage. But even if they went back to average, a lot ofphysicians retiring now could end up having half of whatthey thought they were going to have, just because oftaxes. That's a huge consideration, and it's somethingthat a lot of people aren't looking at."

Fenton points out that most investment advisorsview it as their job to worry about what their clients'assets are doing today. And accountants definitelydon't look at the tax implications because their job is tokeep clients out of trouble with Uncle Sam while savingthem on their yearly tax return. But Fenton believesthat in long-term planning it's important to know whatis possible, what is realistic, what is likely, and what isthe worst-case scenario.

"An investment plan should include a worst-case scenario,"Fenton stresses. "What if we have the worst stockmarket year in history? How will that affect the plan?And what if taxes return to the rate they were in the1950s? And then plan for it. It's much better to be pleasantlysurprised than unpleasantly surprised. And if youplan for the worst-case scenario, there's much more likelihoodof success."