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When mutual funds sell investments throughout the year, the profits from these transactions are transferred to the shareholders of the fund through capital gains distributions.
If your mutual funds are in a taxable account, which is a brokerage account, you will have to pay taxes on the gains realized for the year they were distributed.
However, if you hold mutual funds in a tax-advantaged account – that is, a 401 (k) plan or an individual retirement account – you will not have to worry about it because the gains are deferred. until you withdraw money in retirement.
"If you're a long-term investor, it does not matter," McAleer said. "It's the dilemma of the short-term investor."
In general, capital gains are less likely with ETFs because of the way they are constructed and traded. This generally makes them more tax efficient.
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