A balanced index fund is an investment fund that tracks a pre-determined set of investments, called an index. In addition to being an index fund, it also combines different types of investments so that it gives a way to balance money into different parts of the market. One example of this is a fund that splits invested money between two indexes -- a bond index and a stock index. Such a fund has a number of tax advantages.
Easier Tax Filing
With a balanced index fund, you have one investment that spans two asset classes. This means that you only receive one dividend check and one capital gains distribution check. When you sell, you only have the one investment to track for capital gains tax purposes, as well. While this doesn't, in and of itself, reduce your tax liability, it does simplify preparing your taxes and tracking your investments.
Fewer Taxable Gains
Typically, index funds are less volatile than actively managed funds. As long as the investments in the index that the fund tracks doesn't change, there's no reason for the fund's manager to engage in transactions, other than to have enough cash available for when shareholders sell and redeem their investments. Since the fund has less turnover, there's less risk of shares that the fund holds getting sold for a profit and creating taxable capital gains distributions than with an actively managed fund.
Some balanced index funds are managed to be especially tax-efficient. One way to do this is to structure the bond component of the fund to own municipal bonds instead of government or corporate bonds. Since municipal bond interest is federally tax-exempt, this helps to reduce the amount of taxable interest that the fund generates. At the same time, the fund can also be managed to reduce dividend income, which otherwise would have to be passed through to the fund's owners as taxable income.
One way to essentially eliminate any tax considerations while owning a balanced investment fund is to hold it in a tax-deferred or tax-free account like a traditional or Roth individual retirement account. These accounts encapsulate the funds, keeping the income they pay away from their owners' taxes. The only time these funds generate tax liability is when the owner sells the fund and pulls the money out of a traditional IRA or pulls profits out of a Roth IRA through a withdrawal that doesn't follow the Internal Revenue Service's rules for tax-free distributions.
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