Would you like to buy a low cost index fund at a discount? Would you like no taxes for many years?

That opportunity is now available in low cost index funds. While the mother of all index funds, the Vanguard 500 Index, still has 2 percent of its portfolio value in capital gains exposure (according to Morningstar), index funds that were formed more recently have portfolio losses. An investor who dares to buy shares will receive two benefits as a consequence. First, he will not be buying a tax liability--- the fund has more losses than gains. Second, the fund can appreciate substantially before it will have any capital gains to distribute.

If you had bought an index fund three or four years ago your potential capital gains exposure might have been about 20 percent of assets. Assuming a 20 percent tax rate on long-term capital gains this means 4 percent of your purchase was a tax liability you would eventually realize. Basically, you were getting 96 cents per dollar invested.

Today the situation is reversed. New investors buy a future tax savings that can be worth up to 10 percent of assets per share. A universe of 94 index funds with expense ratios under 0.70 percent and assets of at least $25 million has an average potential capital gain exposure of minus 17 percent. Twenty-seven of these funds have potential capital gain exposures exceeding minus 25 percent. That's the equivalent of a 5 percent tax "bonus."

These figures come Morningstar data for the end of August. So it is a near certainty that current figures are higher, not lower.

Here are some examples:

•           Waterhouse Dow 30 (ticker WDOWX) requires a $1,000 minimum investment and has an expense ratio of only 0.06 percent. It has a potential capital gains exposure of minus 22 percent.   It can rebound 22 percent before you will have a capital gains tax liability.

•           Schwab Total Stock Market (ticker SWTSX) requires a minimum investment of $50,000 and has an expense ratio of 0.27 percent. The fund also has a potential capital gain of minus 35 percent of assets. This means the fund can rise 35 percent before it will have a capital gains liability. In effect, this is a 7 percent discount on net asset value. While it has a higher expense ratio than Vanguard Total Market Index Fund (ticker VTSMX, minimum purchase $3,000) with its 0.20 percent expense ratio, the Vanguard fund has a potential capital gain of 'only' minus 20 percent. The potential tax difference is 3 percent of assets.   It would cover the higher expense ratio of the Schwab fund for many years.

•           Fidelity Spartan Extended Market Index (ticker FSEMX) requires a minimum investment of $15,000. It has an expense ratio of 0.25 percent. It also has a potential capital gains tax exposure of minus 48 percent of assets. As a consequence, it could rise 48 percent before shareholders would have a capital gains liability. The Vanguard Extended Market Index fund requires a smaller minimum investment. It has the same expense ratio and a capital gains exposure of 'only' minus 19 percent of assets. All other things being equal, you would get a 27 percent gain advantage   in the Fidelity fund, tax-free.

•           Vanguard Growth Index (ticker VIGRX) and Vanguard Value Index (ticker VIVAX). These funds, which are based on the growth and value subsets of the S&P 500 Index, have potential capital gain exposure of minus 37 percent and minus 31 percent, respectively. So they can appreciate that much without a tax liability. This is like buying a closed end fund at a discount to net asset value.

Now let's look at the 'value' of the negative capital gains exposure as a way to underwrite the annual expense ratio. With a built in tax saving of 9.6 percent of assets (minus 48 percent times 20 percent capital gains tax rate) Fidelity Spartan Extended Market Index has a tax benefit equal to 38 years   of its annual expenses. Vanguard Growth Index, with a built in tax saving of 7.4 percent of assets has a tax benefit equal to nearly 34 years of its annual expenses.