When a mutual fund minimizes the income earnings and capital gains it distributes to its shareholders, it may be described as a tax-efficient fund.
In general, the smaller a fund's turnover, or the less buying and selling it does, the more tax-efficient it has the potential to be. That's one reason why index funds, which buy and sell investments only when the composition of the index they track changes, are generally tax-efficient.
In addition to reducing turnover, actively managed funds may increase tax efficiency by emphasizing investments expected to grow in value over those that produce current taxable income, or yield. And they may postpone the sale of certain investments until they qualify as long-term capital gains, making them subject to a lower tax rate.
Funds that emphasize tax efficiency generally include that goal in their statement of investment objectives.
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