Many mutual funds distribute capital gains and income to investors at the end of the year, and this year could bring big payouts.
To help you prepare, FundX President Janet Brown shared five things you need to know about distributions with Forbes.
You’ll learn how you can avoid buying into an unexpected tax liability and you’ll see why distributions can make it seem like your fund lost money when it really hasn’t.
Here’s the first three things you’ll need to know:
1. Distributions can add to your tax bill
If you hold funds in a taxable account, distributions are taxable to you, whether you take them in cash or–as most people do–have them reinvested to buy new shares. “Trade carefully at year-end. “If you buy a fund right before it distributes, you’ll be buying a tax liability before you’ve even participated in the fund’s performance.”
2. Distributions may appear to affect fund performance
When a fund distributes capital gains or income, its share price drops by the amount of the distribution. “Returns in my NoLoad FundX newsletter are all adjusted for all distributions, but if you look at a reporting service like Yahoo Finance, a fund’s dividends may be missing, and this can make it look like your fund lost money when it really hasn’t,” Janet explained.
3. Distributions aren’t based on how long you’ve held a fund
“How can I get a long-term capital gains distribution when I’ve only owned the fund for a few months?,” an investor asked us recently.
“The tax status of a fund’s capital gain distribution is determined by how long the fund held an underlying security, not how long you owned the fund,” Janet wrote. “This is why you can receive a long-term capital gain distribution from a fund that you’ve only held for a few months or a short-term capital gain distribution from a fund that you’ve held for many years.”
To learn how bond funds make distributions and why a fund may have negative performance and still distribute gains, click here to read Janet’s Forbes piece, Mutual Fund Alert: Expect Big Taxable Distributions This Year.