October 3, 2008 In the scenarios below, the funds are identical except for their tax efficiency. The amount of tax you pay is the same in either case. But in the non-efficient fund you pay taxes sooner, costing you money that you could otherwise invest. The longer you hold a fund before selling, the more advantageous it is to hold a tax-efficient fund.November 2008 Tax-efficient fund: You buy 100 shares of a fund selling at $10 per share. Non-tax-efficient fund: You buy 100 shares of a fund selling at $10 per share. December 2008 Tax-efficient fund: No distribution. Your holdings are unchanged. Non-tax-efficient fund: Fund pays $1 per share in long-term capital-gains distribution. Price is reduced by $1, to $9. You reinvest the distribution and now have 111.11 shares worth $1,000. Reinvesting distribution raises your tax basis by $100, to $1,100. Advertisement April 2009 Tax-efficient fund: File 2008 tax return. No taxes due to fund activity. Non-tax-efficient fund: File 2008 tax return. Pay $15 in capital- gains tax on the $100 distribution. November 2009 Tax-efficient fund: After fund appreciates 10%, you sell and collect proceeds of $1,100. Non-tax-efficient fund: After fund appreciates 10%, you sell and collect proceeds of $1,100. April 2010 Tax-efficient fund: File 2009 tax return. Pay capital-gains tax of $15 on $100 profit. Non-tax-efficient fund: File 2009 tax return. No additional capital-gains tax because your proceeds equal your tax basis.