Another good year for funds means higher tax bills for some; stock pickers still struggling

Even the most pleasing ice cream on a hot summer day can result in a headache.

Such is the pain mutual-fund investors are feeling as they prepare their taxes. Another year of sweet returns for stock funds is leading to bigger tax bills for many who own funds in taxable accounts.

That, plus some other trends from around the fund industry:


Funds charged ahead in 2014, after the Standard & Poor's 500 index rose by more than 10 percent for a third straight year. But the sizeable gains also pushed many funds to pass along bigger capital-gains distributions to their shareholders.

Each year, funds tally the gains and losses they made from selling stocks. They then pass on those gains to shareholders, usually in December. Investors who own funds in a taxable retirement account must pay taxes on these distributions, even if they don't sell any shares of the mutual fund.

Now that the S&P 500 has more than tripled since hitting bottom six years ago, funds are generally booking profits when they're selling shares of any stock in their portfolios. And that means many funds passed along higher capital-gains distributions for 2014.

A jump in corporate takeovers last year also pushed the numbers higher. At the Hennessy Focus fund, for example, shareholders received a long-term capital-gain distribution of $5.11 per share in December. That's nearly five times what they received a year before.

The fund generally aims to hold on to stocks for at least five years, and that buy-and-hold approach usually results in smaller gains distributions. The fund's 10-year returns rank in the top 9 percent of its category after adjusting for capital-gains and other taxes, according to Morningstar.

But last year, two companies that the fund owned were acquired, says Ira Rothberg, co-portfolio manager. That forced the fund to sell their shares, which triggered more gains.


Last year was a struggle for most stock pickers looking to beat the S&P 500, even more than the year before.

Most large-cap fund managers fell short of the index, 86 percent last year, up from 56 percent in 2013, according to S&P Dow Jones Indices. It continues a yearslong trend for active managers. Over the last decade, 82 percent of large-cap managers have failed to match the S&P 500. The last time the majority of them beat the index was in 2007.

Fund managers specializing in other areas of the market likewise struggled to keep up with their respective index. The majority of small-cap U.S. stock managers failed to keep up with the benchmark both last year and over the last decade. Same with managers who focus on mid-cap stocks. And emerging-market stocks. And real-estate investment trusts.

Bond fund managers had more success. The majority who focus on high-quality, intermediate-term bonds either matched or beat the benchmark both last year and over the last decade, for example. Same with managers who focus on global bonds.

With so many funds struggling to beat their benchmark index, dollars have increasingly gone to those that simply try to mimic stock indexes. Index funds also have lower costs.

U.S. stock index funds attracted $183 billion in net investment over the last year, according to Morningstar. Their actively managed rivals, meanwhile, reported net withdrawals of $125 billion leave.


They're some of the hottest investments around, but many investors still aren't sure what good they are or how they work.

They're exchange-traded funds, and they control more than $2 trillion in assets. The amount has more than doubled in the last five years, but only one in three individual investors has an ETF in their portfolio.

A survey from BlackRock, the largest ETF provider, and Fidelity Investments asked investors what information they lack about the fast-growing area. Among those who don't own any ETFs, 51 percent said "the benefits of ETFs," while 49 percent said "how ETFs work."

ETFs are similar to traditional mutual funds in that they offer an easy way to make a diversified investment. Some ETFs track the S&P 500, for example, while others try to mimic the MSCI Emerging Markets index of 836 stocks. But they differ in how they trade: ETFs can be bought and sold throughout the trading day, like a stock, whereas traditional mutual funds are priced only at the end of each day. ETFs also tend to have relatively low expenses.

One of the risks, though, may arise from one of ETF's benefits. It's important to avoid the temptation of buying and selling too often, regardless of how easy they are to trade.