10) The Supreme Court recently heard a case involving muni bonds. What is it about?

A. Whether muni bonds can be subject to the alternative minimum tax

B. Whether a state can tax interest on most out-of-state muni bonds while exempting interest on its own

C. Whether muni bonds may "guarantee" returns to out-of-state investors

ANSWER: B. The justices were asked to reverse a Kentucky court ruling that said the state couldn't favor its own bonds, in a case being closely watched by other states with similar laws.

The argument largely comes down to whether munis are akin to milk -- or trash. The lawyer challenging the Kentucky law argued that preferential treatment is unconstitutional because the court has ruled that states cannot put up protectionist barriers around their dairy industries. But Kentucky's lawyer cited a ruling that allowed two New York counties to discriminate on their own behalf by requiring trash haulers to deliver waste to publicly owned disposal facilities when cheaper private-sector alternatives existed.

If the Kentucky court ruling stands, single-state muni funds would become irrelevant."

Many mutual-fund investors will get an unpleasant surprise from their tax preparer this year: A bill for the distributions they got from their funds, even though those funds may have had a disappointing year.

Year-end numbers for 2007 are not available yet, but it's clear that distributions will amount to a record of more than $500 billion. You read that right: a half-trillion dollars, nearly $100 billion more than in 2006, and that was the previous record.

That means $1 of every $23 invested in funds today was recycled, passed back to the shareholder and, in most cases, back to the fund again, creating a tax liability along the way. By the time final numbers are in, investors with taxable fund accounts will have paid Uncle Sam more than $25 billion for the privilege of playing buy-and-hold in 2007."

When investors decide to exit an ETF they can sell their shares in the open market. In some cases, the authorized participant will redeem large chunks of ETF shares directly with an ETF sponsor like WisdomTree, performing what's called an "in-kind" redemption. In essence, they reverse the initial purchase transaction. So WisdomTree would return that sampling of individual shares in its portfolio to the AP in exchange for the ETF shares. The twist: WisdomTree will generally return the shares with the lowest cost basis — the ones it paid the least for and, hence, the ones with the highest potential capital gains — in order to hold down its potential tax hit. The AP doesn't care because its tax basis will be based on the current share price. The IRS perceives the whole deal as two companies exchanging one type of share for another, so it's not considered a taxable event.

That transaction method helps insulate existing ETF shareholders from unexpected capital gains — a luxury mutual fund holders don't enjoy. Indeed, an investor who leaves a mutual fund can potentially trigger capitals gains in their wake, since a manager has to sell shares to pay them off. Meanwhile, an investor who leaves an ETF pays taxes on his own profits; the existing shareholders don't get whacked with any unexpected capital gains."

• Consider index funds or exchange-traded funds. Broad-based index funds, which track benchmarks like the Standard & Poor's 500-stock index, rarely pass out capital gains because they don't trade much. For the most part, they vary the securities they own only when companies are added to or subtracted from their benchmarks.
• Broad-based ETFs can do index funds one better. They have a special way of creating and eliminating fund shares that makes distributions even rarer.
• Check out after-tax returns. The Securities and Exchange Commission requires funds to publish after-tax returns, which assume investors pay the highest applicable tax rate on dividend and capital gains. You may not actually have to pay the highest tax rate, but the figures are a good tool for comparing funds' track records.
• Put active funds in your retirement account. If you are building a broad portfolio with several types of funds, consider keeping tax-friendly index funds in your taxable investment account and actively managed funds that trade more frequently in a 401(k) or individual retirement account.
• Do some tax-loss selling. Remember how fund managers can use losses to offset capital gains? You can do the same thing. If you have fund shares or other investments that are worth less than you paid, you might "harvest" the losses by selling them."

The short answer is it doesn't. The NAV [Net Asset Value or fund price] will drop by the amount of the distribution. For example:

To make this example simple, assume that Fund A's stock holdings don't change in value during this period.

Fund A was worth $5.60 a share on December 5^th (the record date).

On December 6^th, the X-Date in this example, the Fund's stock holdings didn't change in value, but the NAV did drop by $0.05 to $5.55 to reflect the $0.05 per share distribution it intends to pay those share holders who held the fund on the record date.

On December 7^th, the distribution date, the fund pays out the $0.05 per share distribution.

If your account value was $10,000 at the start of this period, it is worth $10,000 at the end of the period and if you chose to have the mutual funds reinvested, you will still hold $10,000 of Fund A.

This example is simplified because it ignores regular changes to the NAV from stock or bond movements that it holds."

Fund industry experts are predicting a double whammy this year that we haven't seen since the tech bubble burst. Not only will investors be staring at flat or dismal returns, but they'll also be faced with paying taxes on big capital gains distributions from the well-performing funds they held before the recent turmoil began. Lipper senior research analyst Tom Roseen estimates that investors may pay 20% to 30% more to the federal government than the $24 billion they shelled out last year. That means the typical investor, depending on how much they've saved in certain funds and what type of an account that money is in, could face a tax bill of thousands of dollars. 'We could easily hit the highest tab investors have ever seen,' says Roseen."