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Investing in mutual funds is an easy way to diversify a portfolio, which is one reason why they’re commonly found in retirement plans such as IRAs and 401(k)s. But if you hold such funds in taxable accounts, or are considering such investments, beware of these two tax pitfalls of mutual funds:
Mutual funds with high turnover rates can create income that’s taxed at ordinary-income rates. Choosing funds that provide primarily long-term gains can save you more tax dollars because of the lower long-term rates.
Earnings on mutual funds are typically reinvested, and unless you keep track of these additions and increase your basis accordingly, you may report more gain than required when you sell the fund.(Since 2012, brokerage firms have been required to track — and report to the IRS — your cost basis in mutual funds acquired during the tax year.)