Capital Gains Distributions and the Value of Flexibility

Like playing a new and complicated board game, navigating tax considerations can feel like an endless maze of rules and complexity. The many forms, detailed instructions, and evolving rules that vary based on individual circumstances may tempt investors to ignore all that goes into tax-efficient investing. But just like understanding the basic objectives and rules in a board game can set you up for success, understanding the key drivers of tax efficiency in the funds you invest in can help enable you to better plan out your financial moves.

Mutual funds and ETFs are required to distribute net capital gains annually. These capital gains can result when a fund sells a security at a profit and are distributed to all shareholders, regardless of a specific investor’s realized gain or loss on their fund position. Short-term capital gains are generally realized when a security is sold a year or less from purchase and are taxed at an investor’s (higher) ordinary income rates. Long-term capital gains are taxed at lower rates and can be realized when a security is sold after holding it for more than a year. When funds distribute these capital gains, investors who hold the fund in taxable accounts are subject to taxes. Investors can pay those taxes out of the distributions and reinvest the after-tax proceeds back into the funds, but many investors prefer to defer funds’ capital gains distributions so that their pre-tax wealth can grow for longer.

All of Dimensional’s ETFs and the majority of our equity mutual funds are estimated to pay zero capital gains distributions in 2025, helping to put control back into investors’ hands on when to realize capital gains.¹ Investors holding funds with zero or low capital gains distributions have more flexibility to consider the optimal timing to realize gains based on their individual circumstances. They may consider their tax rates now, the tax rates they anticipate in the future, potential offsetting losses they may have realized elsewhere, whether they plan to donate or bequeath their assets, and other taxable events they may be building into their financial plan when determining an optimal time to realize any capital gains taxes on their fund shares.

Dimensional’s tax-efficient approach within equity strategies has translated into lower estimated capital gains distributions than the industry average when comparing equity mutual funds (see Exhibit 1). Dimensional’s portfolios go beyond a rigid indexed approach by embracing the value of flexibility and incorporating information about expected returns and expected costs into buy and sell decisions each day. This daily process, coupled with our low turnover, broadly diversified approach, and tax-smart rebalancing, has allowed our portfolios to be mindful of tax costs while maintaining focus on pre-tax returns. Our equity mutual funds are estimated to distribute an average of 0.00% short-term capital gains and less than 0.25% in long-term capital gains in 2025. Our process also applies a thoughtful approach to managing dividend income to help reduce tax costs.

While taxes may be one of the few sure things in life, having flexibility over the timing of taxes can provide investors with more control over their financial plan.

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