Excerpted from Bogle on Mutual Funds by John C. Bogle, pages 214

You should not purchase the shares of a mutual fund without being aware of two highly significant figures: (1) the capital gains that have been realized but not yet distributed by the fund and (2) the unrealized capital appreciation or depreciation in the fund's portfolio. Both figures should be available on request from the fund's sponsor.

1. Realized capital gains. If you are a taxable investor, you should never purchase the shares of a fund immediately before it distributes a substantial capital gain (or, for that matter, a substantial income dividend). While the total value of your investment would be the same after the ex-dividend date as before, that value would be effectively reduced by the taxes incurred on the distribution. Assume that a fund with a net asset value of $10.00 per share distributes a $1.00 per share capital gain. Other factors remaining equal, the fund's net asset value automatically drops to $9.00 per share; however, including the capital gains distribution of $1.00, there is no change in the adjusted net asset value of each share. But a federal tax of $0.28 per share must then be paid, leaving an adjusted net asset value of $9.72. There is no reason to accept this penalty; simply wait until after the ex-dividend date to invest your assets. Waiting a few days to invest is only common sense; waiting a few months may or may not be profitable depending on the increase or decrease in the fund's net asset value. Whatever the case, you should carefully assess the amount of a fund's realized gain when you are considering the purchase of the fund's shares.

2. Unrealized capital gains. You should also be aware of the amount of unrealized gains in the fund's portfolio, which may later be translated into taxable realized gains, or unrealized losses which may be used to offset future realized capital gains. If you purchase shares in a fund with a $10.00 net asset value and a cost basis of $8.00 per share, ultimately the $2.00 gain is likely to be realized and distributed, and you will be subject to taxes when it is. Alternatively, if the net asset value is $10.00 and the cost basis is $12.00, the fund can (during the subsequent five years) realize $2.00 of gains, none of which need be distributed or taxed. In an extreme example, assuming each fund realized an additional $2.00 of gains, the first fund might distribute $4.00 of gains and the latter nothing. Although most comparisons are unlikely to be that extreme, you should consider the potential tax liability or the potential tax benefit of a fund, by ascertaining the cost basis of the fund's shares.