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What Just Happened to my Mutual Fund?

What happened to my mutual fund? Why did the price drop so much today?

Don’t panic! November and December mark the time of year when mutual funds make capital gains distributions. That means they are distributing out to shareholders the gains they have generated from buying and selling stocks. When they make these distributions, the “net asset value” or price you see for the ticker, will go down because that price reflects the value of all their underlying assets. So if they distribute $4 per share, the NAV will go down by $4, but you received a $4 distribution to offset the drop.

That’s great news, right? I just got a huge distribution from my mutual fund so they must be doing a great job generating all these gains!

Not necessarily. We’ve seen an extended bull market over the last few years so it would be difficult to NOT have some stocks with gains right now. Many funds started to cut down on their equity allocations this year or had to sell stocks to meet redemptions. As a result they generated substantial gains. In fact some funds this year could distribute gains in excess of 30% of the net asset value of their fund! When those gains are distributed to you, you pay tax on them, unless of course they are held in a tax-deferred account.

Ok but at least the gains will be taxed at lower long-term gains rates of 15%,  right ?

Yes, for any gains that are long-term; they will be taxed at a lower rate, which in most cases will be 15%. Unfortunately,  the new net investment income tax could tack on an extra 3.8% to that rate if your income is over $250k joint/$200k single, and if your income is over $400k/$450k, your rate might be 20% instead of 15%! So that 15% could be as high as 23.8% for some people. It’s even worse if the fund is distributing any short-term gains which are taxed at your ordinary income tax rates. And don’t forget state taxes too!

Wait I just remembered, I reinvest all my dividends and capital gains right back into the mutual fund. I can’t be taxed on distributions if I never receive them can I?

Unfortunately, reinvesting the proceeds from a capital gain distribution has no impact on their taxation. Once the distribution is made to you, you must report it on your return and pay tax on it.

Well, can’t I just ask the mutual fund company to hold onto my money?

If only it were that easy! Mutual funds are required by law to distribute nearly all of the capital gains they generate.

So there’s nothing I can do to avoid these capital gain distributions?

There are many mutual funds out there that have lower turnover and therefore generate far less in capital gain distributions each year. Investing in these types of funds or passively managed ETFs might be beneficial, especially if you are in a high tax bracket.

But what about this year? There’s nothing I can do now?

This is why year-end tax planning is so important! We like to run a year-end tax projection for all of our clients to see where they stand and see if there are any tax planning strategies we can take advantage of. For example, if your income is very high this year and your investment income is going to be subject to the surtax, you might want to take some losses from elsewhere in your portfolio to offset gains from your mutual funds. You also don’t want to buy into funds just before a large distribution in a taxable account.

Where can I learn more about this and find out what kind of distributions my funds will have?

Most mutual fund companies will put out an estimate of the gains for each of their funds before the distribution is made. You can usually find these on the company’s website, but there’s a new site calledhttp://www.capgainsvalet.com/ that will find these estimates for many funds for you. In fact they even have an article highlighting some funds that are estimated to have the biggest distributions this year. The site has a lot of great information on capital gain distributions so we recommend you check it out.

The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. Please see Additional Disclosures more information.