Sat, December 12, 2009
Watch Out for Year-end Mutual Fund Distributions
For many people, December is the riskiest month in which to buy into a new mutual fund in a taxable account. This has nothing to do with the gyrations of the stock market, and everything to do with taxes.
Inexperienced investors, eager to buy into a new mutual fund, will sometimes buy into a fund near the end of the calendar year. The problem with doing this is that mutual funds are required to distribute their realized capital gains (i.e., capital gains on security position sold during the year) to shareholders prior to year-end.
If you buy a mutual fund on December 1 and the fund makes a capital gains distribution on December 20, two things happen: the fund’s share price drops by amount equal to the distribution, and you suddenly have a new tax liability. If, like many people, you have set up your mutual fund to use such distributions to purchase new shares, the net effect is that although you haven’t received any money and the value of your fund holdings is the same as before the distribution, the IRS expects you to pay taxes on the distribution. If you’d waited until December 21 to buy the shares, your holdings would be the same and you would have avoided the tax liability (until next year, at least).
So - if you intend to buy into a mutual fund outside of a retirement account (where taxes are not an issue until you actually take money out) this month, take a quick look at morningstar.com’s entry for the mutual fund you’re interested in; find out when the fund distributes its capital gains. Then wait until after the fund’s capital gains distribution date to buy into it.