Mutual funds highlighting their track record always include a disclaimer that reads something like "past performance is no indicator of future returns."
They should also note that past performance may not be an indicator of true returns after gains are taxed.
Instead of that necessary second disclaimer, however, the fund industry is rapidly moving toward something better: the disclosure of after-tax returns in prospectuses and annual reports.
The Securities and Exchange Commission is currently considering a rule that would require investment firms to say not only how funds performed, but how much of the gains investors got to keep.
It's a change that seems to be drawing hardly any opposition, which is not surprising since almost anyone who comes out against this change would be viewed as wanting to keep consumers in the dark. Even the Investment Company Institute, the national trade association for fund firms and a potential opponent of this disclosure reform, has supported the idea.
Still, it is an important move for consumers and one many concerned and tax-aware investors should keep track of.
The way taxes affect fund returns is confusing; the fund industry awakened to tax efficiency several years ago and individual investors have quickly followed suit.
Funds make their money buying and selling stocks and bonds. Shareholders must pay the taxes on a fund's trading profits.
If a fund buys a hot stock and holds it, for example, the value of the investors' shares goes up but - so long as they hold the fund - there is no tax bill due. If the fund sells the stock after a year, any profit is a long-term capital gain (facing a maximum federal income tax rate of 20 percent). If the stock is sold before a year passes, the profit is a short-term gain and is taxed at an investor's ordinary income tax rate.
Funds aggregate their winners and losers and distribute them in a lump, categorizing various parts of the payout as long- and short-term gains.
Shareholders must pay the tax bill on that money unless they hold the fund in a tax-deferred retirement or annuity account. (You face that tax bill even if you roll the gains payout back into the fund and never get an actual check.)
Here's a simple example of how taxes affect performance:
Say two funds start a year priced at $10 per share. At the end of the year, both have grown to $12 per share, but Fund A has been tax-efficient and distributed no gains. Fund B, which has high turnover, paid out $1 per share, on which the average shareholder owes about 30 percent to Uncle Sam.
By avoiding a gains payout, Fund A's after-tax return is 20 percent; Fund B's after-tax performance is roughly 17 percent.
Under current rules, both funds can say they earned 20 percent (the funds' pre-tax gains). Under the SEC's proposed rules, Fund B would also have to show in its prospectus that its after-tax return was lower.
Already, some fund companies provide after-tax numbers on their Web sites. Vanguard, which is best known for its tax-efficient index funds, began publishing after-tax results last year. Fidelity and Schwab post after-tax returns on Web sites both for their own offerings and for other funds sold through their online "supermarkets." Many other fund firms say they intend to follow suit.
Assuming the SEC rule passes, consumers will still need to be aware of what they are getting.
The agency's plan would have investment companies show after-tax returns for one-, five- and 10-year performances and show those results in two ways. The first would show after-tax gains if the investor holds the fund, while the second would factor in profits or losses realized if the investor sells.
The SEC plan calls for that information to be shown assuming the highest federal tax rate (currently 39.6 percent), a move that has drawn some criticism because the 28 percent tax bracket is more likely where the average fund investor will land.
The fact that the disclosures are still being shaped make this an issue that ordinary investors may want to weigh in on. The SEC's official comment period ends June 30.
Until then, you can check out the proposal and e-mail your comments to the agency via the SEC Web site, www.sec.gov. (Click into the section marked "Current SEC rulemaking," then look under "Proposed rules" for file name "33-7809."
Assuming disclosure passes in some form, fund investors next year will end up with an improved way of sizing up a fund's track record.
Charles A. Jaffe can be reached by e-mail at email@example.com or at the Boston Globe, Box 2378, Boston, Mass. 02107-2378.