Top Rated Mutual Funds: All They're Cracked Up To Be?

Americans may be missing out on profit opportunities at home as well as overseas. In a new study, Stanford University economists Joel M. Dickson and John B. Shoven note that despite billions of dollars flowing into mutual funds, the performance rankings of such funds lack information on their long-term aftertax rates of return.

That's a glaring omission because, except for tax-deferred vehicles such as pension investments, both dividends received by the funds and capital gains resulting from their trading are taxable to shareholders. For high-income investors, that means not only that their earnings over the years are far smaller than a fund's reported appreciation but also that an apparently high-performing fund may turn out to be a poor performer on an aftertax basis.

The two economists found, for example, that based on the median return of a sample of 62 mutual funds, $1 invested in 1962 would have grown to $21.89 by 1992 on a pretax basis, compared with $22.13 for a $1 investment in Standard & Poor's 500-stock index. On an aftertax basis, however, the same $1 for a high-income investor would have grown to just $9.87. Moreover, aftertax fund rankings looked a lot different, with one mutual fund that was in the bottom 20% of the sample on a pretax basis winding up ahead of 60% of the pack for upper-income taxable investors.

In light of such findings, it may be only a question of time before mutual funds and published rankings start to provide investors with more information on the funds' aftertax performance.

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