Last week’s answer

Founded in 1982, I’m one of the world’s largest software companies today, raking in more than $1 billion annually. I employ some 3,500 employees across the world and am headquartered in San Jose, Calif. I have something in common with sun-dried, unburned bricks of clay and straw. One of my products evokes gymnastics. Many of my offerings focus on print and Web publishing, as well as digital imaging. I went public in 1986, and my shares have appreciated by more than 15,000 percent since then. Who am I? (Answer: Adobe)

Mutual fund tax bites

The Securities and Exchange Commission (SEC) requires mutual funds to report their returns on an after-tax basis. It’s vital information for mutual fund investors, since taxes shave an estimated 2.5 percentage points off the average mutual fund’s annual return, if it is held in a taxable account, according to a KPMG study. If your mutual fund has been beating the market average by 1 percentage point each year, you may be actually losing to the market, once you factor in taxes.

Many mutual fund managers buy and sell various securities frequently. This is called “turnover.” Holdings sold at a profit result in capital gains that shareholders are responsible for if they hold the shares in a taxable account. The short-term gains are taxed at regular income tax rates, which can hit 35 percent, and long-term gains are, in many cases, taxed at 15 percent.

Imagine that you hold 10 shares of the Blundermann Growth fund in a taxable account at $100 per share (total investment: $1,000). The fund realized $5 per share of gains last year and credits you with $50 in capital gains, lowering the value of your shares to $950. The fund then reinvests the $50 in new shares, leaving you with 10.53 shares worth $95 each, for a total value of $1,000. You’ve broken even, but you have to pay taxes this year on that $50 distribution.

High turnover in a mutual fund has real costs to shareholders. Until recently, however, mutual funds did not suffer from the tax consequences of their moves. With no incentive to restrain any turnover tendencies, average turnover increased from 33 percent in 1975 to 73 percent in 1994 to more than 100 percent in recent years.

Mutual funds’ prospectuses are where you’ll find annual results on an after-tax basis. Funds must offer this data in their prospectuses, but needn’t do so in their sales and marketing materials. It’s smart to learn as much as you can about a fund before investing by reading its prospectus and not just misleading ads.

Learn more about promising mutual funds at www.championfunds.fool.com and www.morningstar.com.

Forgot why he bought

My smartest investment was purchasing 100 shares of IBM stock in 1962. My dumbest move was following the advice of my broker and selling them a month later. The broker said that his company’s research department was forecasting a gloomy performance, with a cut in dividends in the near future. My main blunder was forgetting the many good reasons I originally bought the stock. — George Craft, Lakeland, Fla.

The Fool Responds: It’s useful to jot down the reasons you buy any stock and to review them regularly, to make sure they’re still valid. If you wonder now and then what those 100 shares would be worth today, the nice folks at IBM did the math for us. One hundred shares bought in 1962 would have grown to 7,680 shares today. You would have received about $150,000 in dividends alone over the 42 years and your shares would be worth more than $650,000 today. (Note that 100 shares in 1962 would have cost you $43,900 at the time.) The average annual growth rate of your investment would have been around 7 percent.