Matthew Davis, CFP®
End of Year Distributions
At the end of the year, it is common for us to get a call from a client wondering why a mutual fund dropped 10% in price often when the market has barely moved. This is a completely fair question and fortunately has a good explanation. We call these capital gain distributions and mutual funds often must pay them out by year-end.
It is important to remember that a mutual fund is a shared investment vehicle that holds many individual stocks, bonds, etc. Throughout the year, the mutual fund manager may be selling their positions and recognizing gains and losses. By year-end, a mutual fund might need to pay out a portion of its profits to its account holders.
If the mutual fund needs to pay out 10% of its value as a year-end capital gain distribution, you the fund owner will receive 10% of the fund’s value in cash. Here is a quick example:
Mutual Fund XYZ is planning on paying a 15% distribution by year-end. It is currently trading at $10 a share. You own 1,000 shares of XYZ.
Before the distribution: After the distribution:
1,000 shares @$10 $10,000 1,000 shares @ $8.50 $8,500
Cash $0 Cash $1,500
Total $10,000 Total $10,000
In the end, both totals are the same. One important consideration, however, is what the tax implication of these distributions are. They can be either a short-term (ordinary income) distribution, a long-term distribution, or some combination. If you hold the fund in a tax-deferred or a tax-exempt account such as a 401(k), IRA or Roth IRA, you do not need to worry. However, in a taxable account, you may want to defer purchasing the fund until after the distribution to avoid participating in the gain.