Capital Gains SZN Heats Up: What Investors Could Expect

The table below offers a snapshot of how this translates in dollar terms. We incorporated the average capital gain distribution paid by U.S. equity funds over the last 4 years (2022-2024) along with this year’s estimate of 8.1%. Assuming a $500k portfolio at the start of each year and applying the highest long-term capital gains tax rate (23.8%), that comes to roughly $6-$12k in tax each year. If this year plays out as estimated, that’s nearly $50k in taxes over the last 5 years.

2025 – The broad view

With that backdrop in mind, it makes sense to start the broader asset-class discussion with U.S. equities. They tend to command the largest share of most investor portfolios and have also delivered some of the strongest multi-year returns across asset classes, which means they typically drive the bulk of capital gain distributions. This year is no exception as U.S. equity funds are expected to make the largest distribution relative to other major fund categories, averaging about 8.1%.

This isn’t much of a surprise as the Russell 3000 Index has delivered returns of +20% in five of the last six years and is up 17.4% year-to-date, so most funds are sitting on some hefty, embedded gains. Below, you will see a summary of distribution estimates within the U.S. equity category, broken down in style box form.

First, across market cap, estimated distributions are coming in slightly higher across the board. Large cap funds are averaging 7%-10%, mid-cap 7%-11% and small cap 6% through 8%. Growth-oriented strategies are toward the top of each market cap segment.

Most categories are estimating distributions roughly 1 to 3 percent higher than what they paid out in 2024. Mid-cap growth stands out in particular; after paying the highest distribution among all U.S. equity segments last year, they are estimating an increase of about 3 percent for 2025.

Outside of U.S. equities, international equity estimates are coming in a bit higher than we have been used to, at 7.2% on average. This is partially due to their strong 2025 returns. The largest estimates are seen within smaller and more growth-oriented segments. Sector equity is coming in modestly lower at roughly 6% on average, with a wide range. Growth-leaning sectors are at the higher end, aligning with U.S. style-box trends, whereas real assets and defensive sectors are on the lower side.

Non-traditional equity funds, which include funds focused on derivatives and long-short approaches, are tracking just under 6% on average. Given the nature of these strategies, they tend to be less tax-efficient, so expecting a mid-single digit average estimate isn’t surprising.

Commodities and alternative funds are estimating to pay a distribution toward the lower end of the overall range, with most distributions classified as short-term rather than long-term. Allocation funds are estimating similar levels, with larger averages coming from more aggressive, equity heavy mixes, topping out at 5.7% on average.

Summary - Investor and advisor action steps

While we could go much deeper and dissect each asset class, fund family, or individual funds, investors should use this data as a broad starting point. It can help identify areas that may not be aligned with their taxable interests.

Investors may consider not automatically reinvesting distributions if minimizing current-year tax drag is a priority. Instead, consider directing distributions to more tax‑efficient options that align with your objectives and circumstances. One way to pursue after‑tax wealth growth is to reduce tax drag where possible.

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METHODOLOGY OF CALCULATING AVERAGE CAPITAL GAINS DISTRIBUTIONS OF FUND CATEGORY: The average capital gain distribution as a % of Net Asset Value (NAV) is calculated using long term and short-term capital gain distributions as reported by respective fund families. % of NAV is calculated as ($ capital gain estimate ÷ NAV). For funds that report estimates as a range a mid-point is used [(low estimate + high estimate) ÷ 2]. It is important to understand the NAV date used in this calculation vary by fund family based on each company’s formal distribution announcement. Total Number of funds within each US Category Group: 6,629 for U.S. Equity, 3,836 for International Equity, 1,641 for Sector Equity, 636 for Non-Traditional Equity, 157 for Commodities, 5,877 for Allocation, 414 for Alternative. Total Number of funds within each Morningstar Category: 1,170 for Large Value, 1,386 for Large Blend, 1,088 for Large Growth, 423 for Mid-Cap Value, 403 for Mid-Cap Blend, 495 for Mid-Cap Growth, 488 for Small Value, 624 for Small Blend, 552 for Small Growth.

Investments in small cap, micro cap, and companies with capitalization smaller than the Russell 2000® Index, are subject to the risks of common stocks, may experience considerable price fluctuations and are more volatile than large company stocks. Generally, the smaller the company size, the greater the risks.

Non-U.S. markets, which may include developed, emerging, and frontier markets, entail different risks than those typically associated with U.S. markets, including currency fluctuations, political and economic instability, accounting changes and foreign taxation. Non-U.S. securities may be less liquid and more volatile than U.S. securities. The risks associated with non-U.S. securities may be amplified for emerging markets securities. Because frontier markets are among the smallest, least developed, least liquid, and most volatile of the emerging markets, investments in frontier markets are generally subject to a greater risk of loss than investments in developed or traditional emerging markets.

Commodities may have greater volatility than traditional securities. The value of commodities may be affected by changes in overall market movements, changes in interest rates or sectors affecting a particular industry or commodity, and international economic, political and regulatory developments.

Alternative strategies may be subject to risks related to equity securities; fixed income securities; non-U.S. and emerging markets securities; currency trading, which may involve instruments that have volatile prices, are illiquid or create economic leverage; commodity investments; illiquid securities; and derivatives including futures, options, forwards and swaps.

INDEX DEFINITIONS:

Russell 3000® Index: Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market.

MSCI EAFE (Europe, Australasia, Far East) Index: A free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada.

MSCI Emerging Markets Index: A float-adjusted market capitalization index that consists of indices in 24 emerging economies.

MORNINGSTAR FUND US CATEGORY GROUP DEFINITION:

U.S. Equity: U.S. equity portfolios invest primarily in stocks of U.S. companies, spanning market-capitalization segments from small cap to large cap and investment styles from value to blend to growth. These strategies focus on companies listed or principally operating in the United States and are grouped by size and valuation characteristics—large, mid, and small categories, each with value, blend, or growth orientations. U.S. equity funds may target broadly diversified exposure across industries or emphasize specific risk and style factors tied to the U.S. stock market.

International Equity: International-equity portfolios invest primarily in non-U.S. stocks, including developed and emerging markets. These funds often diversify across countries such as Japan, the U.K., Germany, France, and emerging regions in Asia or Latin America. Categories within this group include foreign large-cap value, blend, and growth funds, as well as foreign small/mid-cap strategies and global allocations that invest primarily outside the United States. These portfolios typically hold less than 20% of assets in U.S. securities.

Sector Equity: Sector-equity portfolios concentrate investments in specific industries or economic sectors, such as technology, health, energy, real estate, communications, consumer cyclical, consumer defensive, natural resources, or financial services. These strategies seek capital appreciation by focusing exposure on companies whose prospects are tied to a particular sector. Because of their narrower focus, sector funds typically exhibit higher volatility and greater sensitivity to industry-specific trends than diversified equity funds.

Nontraditional Equity: Nontraditional-equity portfolios use alternative or derivative-driven strategies rather than straightforward long-only stock selection. These may include long–short equity, derivative-income strategies (such as covered-call overlays), equity-hedged approaches using protective options or market-timing, and defined-outcome structures that use options to cap upside and buffer downside. These funds typically exhibit lower beta to traditional equity markets and seek to manage or reshape equity risk through structured exposures.

Commodities: Commodity portfolios invest in physical commodities or commodity-linked derivatives, such as futures contracts tied to metals, energy, agriculture, livestock, or diversified commodity baskets. Some funds diversify across many commodity sectors, while others concentrate on specific industries such as energy or precious metals. These strategies often serve as inflation hedges or diversifiers because they behave differently from traditional equity and bond markets.

Allocation: Allocation portfolios invest in multiple asset classes — typically stocks, bonds, and cash — seeking a balanced mix of income, growth, and risk control. These strategies differ by the level of equity exposure, ranging from conservative (low equity) to aggressive (high equity), including target-date funds that shift allocations over time. Allocation funds are designed to provide diversified, risk-controlled portfolios appropriate for different investor objectives or time horizons.

Alternative: Alternative portfolios invest using nontraditional investment approaches or exposures beyond traditional stocks and bonds, often including derivatives, event-driven strategies, macro trading, relative-value arbitrage, multistrategy frameworks, or trend-following models. These strategies aim to provide diversification, reduce correlation to traditional markets, exploit market inefficiencies, or generate returns independent of equity and bond market direction. Many alternative strategies use short positions, leverage, or derivatives to reshape portfolio risk.

MORNINGSTAR FUND CATEGORY DEFINITION:

U.S. Fund - Large Value: Large-value portfolios invest mainly in large U.S. companies that are less expensive or growing more slowly than other large-cap stocks. These portfolios favor companies with low valuations (low price ratios, high dividend yields) and slow growth characteristics. Stocks in the top 70% of the U.S. equity market by capitalization are defined as large cap.

U.S. Fund - Large Blend: Large-blend portfolios favor U.S. firms at the larger end of the market-capitalization range. Some aim to own an array of value and growth stocks while others employ a discipline that leads to holdings with valuations and growth rates close to the large-cap averages. Stocks in the bottom 10% of the capitalization of the U.S. equity market are defined as large cap. The blend style is assigned to portfolios where neither growth nor value characteristics predominate.

U.S. Fund - Large Growth: Large-growth portfolios invest primarily in big U.S. companies expected to grow faster than other large-cap stocks. These portfolios emphasize firms with high growth rates for earnings, sales, book value, and cash flow, which often leads to higher valuations (high price ratios and low dividend yields). Most focus on rapidly expanding industries. Stocks in the top 70% of U.S. market capitalization are considered large cap.

U.S. Fund – Mid-Cap Value: Mid-cap value portfolios invest in medium-sized U.S. companies that are less expensive or growing more slowly than the overall market. These portfolios focus on firms with low valuations and slower growth in earnings, sales, book value, and cash flow. Stocks in the middle 20% of U.S. market capitalization are considered mid-cap.

U.S. Fund – Mid-Cap Blend: Mid-cap blend portfolios invest in U.S. stocks of various sizes and styles, giving them a middle-of-the-road profile. These portfolios typically avoid both high-priced growth stocks and deeply discounted value stocks. Stocks in the middle 20% of U.S. market capitalization are defined as mid-cap. The blend style applies when neither growth nor value characteristics dominate.

U.S. Fund – Mid-Cap Growth: Mid-cap growth portfolios target U.S. companies projected to grow faster than other mid-cap stocks. These businesses tend to have higher prices relative to fundamentals and are often found in expanding industries. Stocks in the middle 20% of the U.S. equity market capitalization are considered mid-cap. Growth is defined by fast growth rates and high valuations.

U.S. Fund - Small Value: Small-value portfolios invest in small U.S. firms with valuations and growth rates below those of other small-cap peers. These companies tend to have lower price ratios, higher dividend yields, and slower growth rates. Stocks in the bottom 10% of U.S. equity market capitalization are defined as small cap. Value is defined by inexpensive valuations and slower growth fundamentals.

U.S. Fund - Small Blend: Small-blend portfolios favor U.S. firms at the smaller end of the market-capitalization range. Some aim to own an array of value and growth stocks while others employ a discipline that leads to holdings with valuations and growth rates close to the small-cap averages. Stocks in the bottom 10% of the capitalization of the U.S. equity market are defined as small cap. The blend style is assigned to portfolios where neither growth nor value characteristics predominate.

U.S. Fund - Small Growth: Small-growth portfolios focus on faster-growing U.S. companies in the lower end of the market-capitalization range. These portfolios typically emphasize younger firms or companies in dynamic industries. Because these companies grow quickly and tend to be richly valued, their stocks are generally more volatile. Stocks in the bottom 10% of U.S. market capitalization are considered small cap. Growth is defined by rapid growth and high valuations.

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