Warning Against Year-End Mutual Fund Purchases

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Why is it bad to buy a mutual fund at the end of the year? The primary reason for the warning against buying mutual funds near the end of the year is because mutual funds usually do their mandatory distributions at the end of the year. What’s bad about this is that you’re now forced to pay taxes on that mandatory distribution even though you didn’t earn any of the capital gains. I think an example will clear things up.

Let’s say you bought a hundred shares of Blueprint Growth Fund and the next day, the fund announced a $5 distribution. You’ve opted to reinvest distributions and so that $5 does back into the fund and the price per share didn’t change total value of your investment doesn’t change. Okay, you didn’t lose any money yet… until you do your taxes because that distribution is considered capital gains and now you’re taxed on it. (If you didn’t opt to reinvest, instead of having the same number of shares, you’d have $500 of shares less and $500 in your bank account before taxes, same result) If you had owned the shares at the beginning of the year, it’s likely that your gains would’ve been more than the distribution and you would’ve been a-okay (just business as usual). However, since you bought so late, you’re paying taxes on gains you never enjoyed… unfortunately one of the drawbacks of mutual funds.

In theory, this is just like what happens if you buy a stock right before the company announces a dividend right?

How can you avoid this? Look up or call the fund to see when the distribution date and buy it afterwards.

Why does this matter? It makes sense to avoid this if you’re near the end of the year. Otherwise, you should be buying and holding and not trying to time the market, so I wouldn’t worry too much about it otherwise. Consider this one of the minor course correction type ideas in the nice long voyage that is your personal finance life.

{ 9 comments, please add your thoughts now! }

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9 Responses to “Warning Against Year-End Mutual Fund Purchases”

  1. Also, with all of your retirement accounts you can contribute up until April 15 for the previous year. This gives you a great opportunity to avoid the no benefit taxes.

  2. Kurt says:

    “You’ve opted to reinvest distributions and so that $5 does back into the fund and the price per share didn’t change.”
    I don’t think that’s right. When they declare a distribution, the share price will go down. You will end up owning more shares at a lower price, not the same number of shares at the same price.

    This all comes down to a timing difference, really. You are paying taxes now in place of paying them later (if you then sold the shares the day after the distribution, your basis would be higher than the sale price and you would be able to claim a loss).

    Am I thinking about this correctly?

  3. CK says:

    Jim I think Kurt is right.

  4. CF says:

    Also, this doesn’t matter if you’re contributing to a retirement (or any tax deferred or tax free) vehicle. If it’s a Roth or 529, you never pay taxes (assuming you follow the rules), and if it’s a traditional deductible IRA or other retirement account (tax deductible/deferred), it doesn’t make a difference, correct? Only situation that I see that could be impacted is a traditional NONDEDUCTIBLE IRA (non-deductible being the factor). Is this right or am I missing something?

  5. jim says:

    CK, Kurt – The value of your shares doesn’t change but the number of shares you have will, it’ll increase, so you’re right on that account. You’re paying taxes on the performance of the year and if you were to sell I imagine you’d be able to write down the loss from the cost basis perspective.

  6. CK says:

    The per share price has to drop after a distribution. If it didn’t you could buy the fund right before the distribution and then sell it right after for a quick profit.

  7. jim says:

    Did my article imply that the share price wouldn’t drop?

  8. CK says:

    quote: “… and the price per share didn’t change”

  9. jim says:

    See? I didn’t imply it… I was very clear (flat wrong). 🙂

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