DEFINITION of 'Tax-Efficient Fund'

A tax efficient fund is a mutual fund structured to reduce tax liability. In a tax efficient fund, the structure and operations of the fund are designed to reduce the tax liability that its shareholders face.

BREAKING DOWN 'Tax-Efficient Fund'

Because tax-efficient funds have a low tax liability, they are often good investments to make outside of a tax-deferred account. This is because there is a minimal amount of tax to be deferred and the space in an investor's tax-deferred account is better suited for higher taxed securities, such as dividend-paying stocks.

Reducing the tax liability of a fund is done in three main ways:

1. By purchasing tax-free (or low taxed) investments such as municipal bonds.
2. Keeping the fund's turnover low, especially if the fund invests in stock. Stocks held for more than one year are taxed at a lower long-term capital gains rate than short-term transactions.
3. Avoiding or limiting income-generating assets, such as dividend-paying stocks, which create a tax liability at each dividend issuance.

To determine how much you will save in this type of fund compared to other funds, review the investment company's and/or mutual fund's tracking services for statistics regarding a fund's historic tax costs.

Example of a Tax Efficient Fund

The T. Rowe Price Tax-Efficient Equity Fund pursues the significant return potential of stocks while seeking to reduce the long-term tax burden by investing in a broad range of equities—from mid- and small-caps whose futures appear especially promising, to large companies operating in dynamic industries. In short, it invests in growing firms whose management teams, product lines and balance sheets—among other measures—bode well for their future prospects.

In an effort to achieve strong after-tax returns, the fund seeks to avoid realizing capital gain distributions by limiting sales of existing holdings and not rotating from one sector to another in an attempt to capture short-term outperformance. However, taxable gains may be realized in order to satisfy redemption requests or when they believe the benefits of continuing to hold a security outweighs tax considerations. As appropriate, they may attempt to use losses from sales of securities that have declined to offset future gains that would otherwise be taxable.

The T. Rowe Price Tax Efficient Fund’s top 10 holdings, as of April 30, 2018, were:

  • Alphabet
  • Amazon
  • BlackRock
  • Booking Holdings
  • Facebook
  • Intuit
  • Mastercard
  • Microsoft
  • United Health Group
  • Visa

These 10 holdings represented 22.58% of the total fund. The fund had a 10-year annualized return of 9.92%.

  1. Tax Efficiency

    Tax efficiency is an attempt to minimize tax liability when given ...
  2. Tax Liability

    A tax liability is the amount an individual, corporation or other ...
  3. Deferred Tax Liability

    A deferred tax liability is a tax that is due but has not been ...
  4. Net of Tax

    Net of tax is an accounting figure that has been adjusted for ...
  5. Tax Planning

    Tax planning is the analysis of a financial situation or plan ...
  6. Tax Break

    A tax break is a savings on a taxpayer's liability. It is also ...
Related Articles
  1. Investing

    How Tax-Efficient Is Your Mutual Fund?

    Learn about factors that influence the tax-efficiency of your mutual fund, how income from your investment is taxed and what to look for when choosing a fund.
  2. Taxes

    5 Tax-Efficient Portfolio Tips for High Income Earners

    High income earners can use these tips to make their portfolio more tax-efficient.
  3. Investing

    Comparing ETFs Vs. Mutual Funds For Tax Efficiency

    Explore a comparison of mutual funds and exchange-traded funds, or ETFs, and learn what makes ETFs a significantly more tax-efficient investment.
  4. Investing

    When to buy a mutual fund

    Doing a little research can help you find out if mutual funds are a good fit for your portfolio.
  5. Financial Advisor

    How to Dodge Big Tax Hits on Your Portfolio

    An investment plan that helps clients minimize related tax hits adds even more value to an already well-thought out strategy. Here are some tips.
  6. Taxes

    A beginner's guide to tax-efficient investing

    Different investment accounts have different tax requirements. Find out how to manage your portfolio to minimize your tax burden and keep the most cash.
  7. Investing

    Capital Gains Strategies for High Returns

    Investors who have made significant gains face potential tax liabilities when they sell. Here are some strategies to reduce taxes.
  8. Investing

    7 Tips for Tax-Managed Investing

    Use these seven tips to reduce the tax impact on your taxable portfolio.
  9. Investing

    Mutual Funds That Reduce Your Taxes

    It may be best to opt for ETFs over mutual funds, which allow wiser investors to reduce their tax obligations.
Hot Definitions
  1. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  2. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  3. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  4. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  5. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  6. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
Trading Center