Perspective on Tax Cost
Investors spend a lot of time comparing expense ratios between mutual funds and ETFs. While these are important characteristics, they fall short in capturing the total cost of ownership for investments. Among the many line items beyond expense ratios, one of the biggest may be tax costs.
Taxes can be incurred through a combination of capital gains and dividend income. While ETFs may enable investors to delay realizing gains, income may be a different story, especially if the fund holds securities that distribute nonqualified dividend income, such as REITs.
These tax costs can add up and become a meaningful portion of an investor’s all-in cost. As the exhibit shows, tax cost ratios—the percent of pre-tax return lost after taxes—can be twice as big as a fund’s expense ratio. A fund with a low expense ratio might not seem so cheap once the tax bill comes due.
Morningstar Category Tax Cost Ratio vs. Net Expense Ratio
As of December 31, 2025
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Glossary
Capital gains: Money that may be distributed to shareholders when a fund sells a security for a profit.
Dividend income: A distribution of earnings that companies may choose to pay shareholders.
Dividends, qualified and nonqualified: Qualified dividend income is taxed at lower capital gains tax rates, while nonqualified income is taxed at the higher ordinary income rate.
Real estate investment trusts (REITs): Securities that provide investors with a focused exposure to the income from real property assets. REITs must hold most of their assets in real estate, derive most of their revenue from real estate related sources, and distribute nearly all of their earnings to shareholders.
Disclosures
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