A. If you hold mutual funds in your a taxable account, it is true that you could lose money on your investment on paper, never sold any share, but still have to pay Uncle Sam capital gain tax the following year at tax time.
This happens because by law the each year a mutual fund must pay out to investors nearly all their incomes (e.g. dividends, interests, net realized capital gains, etc.) minus losses to shareholders.
If you hold a mutual fund in a tax sheltered account such as an IRA or 401K account, you are fine. But if you hold a mutual fund in a taxable account (i.e. individual brokerage account), in some extreme cases, you might find the fund you are holding is distributing over 30% or even more of Net Asset Value (NAV).
There is a free website you can do a quick search - capgainsvalet.com - it tracks a list of popular funds with extreme payouts. For example, First Pacific Advisors U.S. Value Fund has distributed over 80% of its NAV in 2015!
In our next two blog posts, we will discuss why some mutual funds have such a high distribution ratio and what an investor could do to prevent such a tax hit.