With the year-end upon us, many investors see it as the time to rebalance their investment portfolios.? However, savvy investors need to be aware of just when the timing is ?right? or ?wrong? to make that buy or sell trade happen.
Mutual funds are required by law to distribute the income earned within the fund each year to the shareholders of the mutual funds in the form of dividends and capital gain distributions. ?Typically, the bulk of these distributions occur near year end, late in the month of December.? The dividends and interest earned within the mutual fund as well as capital gains from sales must be distributed to the shareholders.? At the time of the distribution, the net asset value (NAV) of the fund decreases by the amount of the per share distribution because those assets are no longer held within the fund.? The result is taxable income to the shareholder and a reduction in the NAV of the mutual fund.
Thus, the date to be aware of is the ex-dividend date ? the first day that buyers of the mutual fund will not receive the dividend being paid out by a mutual fund.
Buyers will want to wait until after the ex-dividend date to buy into a mutual fund.? After that date they are buying into the fund at a lower NAV, because of the dividend distribution.? If they buy the mutual fund prior to the ex-dividend date, they are buying the fund at the higher NAV, receiving a taxable distribution, and then being left with the mutual fund at the lower NAV.? The major dilemma of purchasing before the ex-dividend date is that although the buyer will receive income in the form of a dividend and/or capital gain distribution, he will also have to report the income on his tax return and pay taxes on that distribution. ???After having been hit with a tax bill on the distribution, the buyer would be left with less money in his wallet than if the mutual fund was simply purchased without the dividend payment.
The opposite is true for sellers.? Sellers want to sell their mutual fund shares before the year-end distribution.? Selling before the ex-dividend date end will result in the entire gain being subject to lower capital gain tax rates.? Waiting until after the ex-dividend date, the seller will receive a taxable distribution.? This scenario would result in income from the sale of the mutual fund being taxed at a capital gain, but the dividend distribution portion being taxed at a higher ordinary income tax rate.
Bottom line is as follows ? buyers want to purchase shares after the ex-dividend date while sellers should sell shares before the ex-dividend date.? Following these rules should help investors to lessen their tax exposure on their mutual fund income.
I still am unsure about final taxes when selling long term mutual funds. I pay capital gains taxes and dividends every year. Does that mean when I sell 100% of my funds, I will only pay capital gains and dividends for that year, since I have paid taxes all along on earnings?
If not, it seems like I am being taxed double. I own some funds that are pretty active and they are not in a 401K, and I have held for 20+ years.
Hi Chris,
You pay taxes annually on the dividend and capital gain distribution income that you receive each year and report on your personal tax return – whether you take the payout as cash or reinvest the investment income back into the mutual fund. When you sell a mutual fund you pay capital gains tax on the difference between the sale proceeds less the investment’s adjusted cost basis in the year of sale. I assume from your question that the dividends and capital gain distributions you receive from your funds annually are reinvested back into the funds you own. When you own a mutual fund that reinvests investment income back into the fund your cost basis is your original cost of the shares of the mutual fund at the time of purchase plus the investment income reinvested back into the fund. Your adjusted cost basis is increased each year by the reinvested investment income – as more shares are purchased each year. Thus, you are not double taxed on the investment income you’ve received if that income is reinvested back into the fund over the years. Here is an example.
• In 2016 you purchase shares of fund ABC for $5,000
• In 2017 you receive $150 of dividend income that you auto reinvest back into the mutual fund to buy more shares
• In 2018 you receive $200 of dividend income that you auto reinvest back into the mutual fund to buy more shares
• In 2019 you receive $0 of dividend income
• In year 2020 you sell all your shares for $6,000. The result is a taxable capital gain in the amount of $650 (sales price $6,000 less cost basis $5,350 (original cost $5,000 plus reinvested investment income $150 + $200))
Does the buy/sell timing matter if you are holding a fund in an IRA?
On 12-31-2020 I submitted a online purchase order, Vanguard rec 7:30 AM, to buy shares of Vanguard high-yield corp fund (VWEAX) an the “Transaction Confirmation document” I have, dated 12-31-20, shows money was paid/withdrawn from my cash account and a certain number of VWEAX shares transacted on 12-31-20 . 12-31-20, Thur, happen to be the Record date and the Reinvest date ( and last trade day of 2020) with a Distribution payable date of “1-4-2021” I was told by Vanguard that I DO NOT get the distribution because I didn’t own (?? pd cash on the spot) the shares “long enough” to earn it during the month of Dec to receive any distribution. They said if I purchased DURING the month I would get a pro rated share of the total month’s distribution. Is this true?? I think not because my paper work, dated 12-31-20, shows: Exchange to a certain number of shares and the dollar cost of ea and total dollars paid dated 12-31-20. On 1-1-2021 (holiday-mks closed) at 6:25 AM, over night Vanguard computer ops, my account shows those shares were added to my account. I’m 75 and living off of SS and distributions and every penny counts for me these days !!
I own a Vanguard (cash) Mutual fund VWENX . Gains are reported on 1099-DIV of, usually $5K/year. I want to sell the fund and invest in a Tax-Managed Vanguard fund. Vanguard rep advised me that the sale (during February) would result in approximately $5k taxable gain. Please explain why such a gain can bed realized only after the fund is nearly flat YTD.
I’m hoping to learn of the best time to sell the fund. Thank you for your opinion