It’s a financial truism.

When markets experience a good year, mutual fund investors can expect capital gains distributions in December.

This year, with double-digit returns providing a welcome boost to portfolios, investors are surely feeling grateful—and there’s no reason to let taxes on distributions diminish this attitude of gratitude.

Fund Distribution Basics

Whether we like it or not, mutual funds are required to distribute any realized gains to investors at the end of each year.

These payouts are generally taxed at a federal rate of 15% for most individuals, although short-term gains are taxed at potentially higher ordinary income rates.

While it’s hard to predict distribution amounts and prepare for related taxes, there are ways to keep more of those returns—and stay abundantly thankful.

Avoid Actively Managed Funds

When a portfolio is managed effectively, mutual funds ideally distribute fewer gains and incur lower taxes.

Some mutual funds, however, are more likely than others to have large capital gains distributions—and higher taxes.

Actively managed mutual funds, for instance, tend to have bigger payouts because active fund managers buy and sell frequently in an attempt to boost returns.

In addition, the tsunami of outflows from actively managed funds in favor of index funds may further increase distributions because outflows require fund managers to sell holdings to cash out departing investors.

Fewer shareholders remain holding those active funds, which means distributed gains fall on a smaller group of shareholders—who then get stuck with a bigger tax bill.

Invest in Tax-Friendly Funds

Vista has long favored tax-friendly index- and exchange-traded funds from Vanguard and broad-based asset class funds from Dimensional Fund Advisors (DFA).

These funds tend to trade their holdings much less frequently compared to actively managed funds, whose managers frenetically dart in and out of stocks.

Less frequent trading helps keep a lid on taxes, ensuring the lion’s share of a fund’s return ends up in the investor’s pocket.

Keep an Eye on Funds with More Targeted Holdings

Not all of Vista’s funds, however, are immune to sizeable distributions.

Funds with a smaller eligible universe of holdings—U.S. and international small cap value, for example—generally produce larger distributions (2% to 3% this year) than “core” or “total market” funds because of the former’s more targeted holdings.

For example, when small stocks perform well and become larger, small cap funds must sell them to maintain style purity.

This consistent exposure is a good thing—it’s one of the reasons we seek to hold these funds in clients’ retirement accounts whenever possible.

Additional Steps to Maximize Returns

Vista takes steps year-round to maximize investor returns.

First, we consider asset location, or selecting the best place for investments.

Funds less likely to generate distributions tend to be better held in taxable accounts. By contrast, funds that are less tax friendly are held in tax-deferred accounts whenever possible.

We also strategically use tax loss harvesting—trimming positions trading at a loss and immediately replacing them with a similar investment—to offset gains realized elsewhere.

We’ve Got Your Back

Vista is always working to minimize the tax impacts of capital gains distributions—a great reason to stay thankful in a banner year for investors.