The tax-cost ratio of a mutual fund or exchange-traded fund (ETF) measures how much that fund’s annualized return is reduced by the taxes it must pay on distributions to investors each year—typically from dividends, interest and capital gains. A fund’s turnover rate correlates with its tax-cost ratio in the event that the management team sells a holding and then distributes the capital gains to the fund’s investors. These essential stats are at your fingertips when evaluating mutual funds and ETFs.
In both the Fund Evaluator and the ETF Evaluator—which can be accessed by typing the fund name or ticker into the search tool at the top of AAII.com—portfolio turnover is available in two places on the Overview page. It can be found first at the top of the page under the fund’s name, included as part of a summary of key figures investors should consider.
An individual investor is taxed for two types of events when holding a stock: when the stock provides income in the form of a dividend and when it provides income in the form of capital gains if sold for a profit. Since a fund is made up of many stocks—in the case of an equity fund—investors must pay taxes on the capital gains and dividends for many stocks. If a fund has a higher turnover rate than a category peer, you should expect that fund to also have a higher tax-cost ratio due to the increased frequency in which income is distributed to that fund’s investors through capital gains.
This logic plays out on a macro-scale between ETFs and mutual funds as well. Because the majority of mutual funds are actively managed, they tend to have higher turnover rates. Because most ETFs are passively managed, tracking an index for example, they tend to have lower turnover rates. Due to these factors, you would expect an ETF to have a lower tax-cost ratio than a mutual fund.
Scrolling down the Overview page, turnover can also be found under Portfolio Statistics for ETFs and under Portfolio Characteristics for mutual funds. In these sections, you will also find information about how often a fund distributes income to investors.
A fund’s tax-cost ratio is reported at the bottom of a fund’s Trailing NAV Total Returns table in both the Fund Evaluator and the ETF Evaluator. The tax-cost ratio is provided for total annual return periods of one year, three years, five years and 10 years, so you can see how the tax-cost ratio has changed over time and its impact on the total return.
