Bad Timing: Get Ready for Higher Taxes on Your Investments

For example, if a mutual fund bought an energy stock back in 2003 and then sold it early this year, there's a good chance the fund realized a sizable profit. So even though the fund has dropped in 2008, it still realized a taxable gain on that energy stock and soon will be passing on that gain to the shareholders.

In many instances, there may have been a good reason for the fund manager to sell a particular stock. However, the market panic we've experienced over the past couple months has made the capital gains problem worse for mutual fund shareholders.

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As investors have panicked and sold their mutual fund shares, fund managers have had to sell off stocks they wanted to keep, increasing the level of gains that will be passed on to the shareholders left behind.

Types of mutual funds particularly susceptible to large capital gains distributions in the face of huge 2008 losses include those specializing in emerging markets, energy and natural resources stocks. Each of these fund categories posted huge returns for investors over a few years before diving in 2008.

This year, they've been selling stocks that provided outstanding profits in 2006 and 2007, triggering a tax bill for investors despite the declines this year.

For example, the Matthews China Fund is down more than 50 percent this year after posting a 65 percent return in 2006 and a 70 percent increase in 2007. On Friday, it announced a distribution of long-term capital gains amounting to $6 a share on a fund trading for around $18 a share.

That means if you owns 100 shares of that fund, you'll be paying tax on a $600 capital gain for an investment worth about $1,800. If you bought those shares in 2005 and shared in the terrific returns of the next two years, then you might not be too upset.

However, if you bought into the fund at the start of this year and watched your investment lose more than half its value, then you will be quite upset.

The Matthews China Fund is not the only one. Other funds due to pay out large capital gains to shareholders after posting huge losses this year include the Dreyfus Premier Emerging Markets Fund, U.S. Global Resources Fund and many others.