capital gains distribution

Capital gains distribution can be a big issue for mutual fund holders. Some folks try to end-run this by selling the fund before the distribution date – usually some time in November. In his article, John Hussman explains what happens for his funds, and why most people would not get a tax benefit from this tactic.

The quotes are from Pump It Up November 5, 2007

  • Just a note – The Hussman Funds generally pay their required capital gains distributions during November, which I expect to represent in the area of about 4% of each Fund’s net asset value.
  • The net asset value of each Fund, of course, declines by the amount of the distribution on the ex-day (thus reducing later capital gains liability).
    ? distribution out as additional shares (approx 4% of value) but net asset value stays the same, therefore each share “worth” less ?
  • In the Strategic Growth Fund, the entire distribution is expected to be long-term in nature. In the Strategic Total Return Fund, the distribution is expected to be about half long-term and half short-term in nature.
    Quicken picks up this information from downloaded transactions with shares and amount as ReinvLg and ReinvSh
  • In both cases, the distribution is expected to be less than the one-year appreciation in the Funds, so investors trading to avoid the distribution would generally increase their tax liability.
    mseiebert – “as a general rule” regarding distribution date – sell before, buy after, however doesn’t say to do this every year, but it could be taken to mean that?
  • There’s a lot of misunderstanding about mutual fund distributions. Investors seem not to take into account the tax impact of the offsetting reduction in NAV.
    NAV net asset value
  • If you work through the math, you’ll find that when a distribution is partly long-term in nature, the true “tax cost” of taking the distribution is negative for short-term holders, meaning that they have an incentive to hold the Fund in order to capture the distribution.
  • Meanwhile, long-term holders have no incentive to avoid a distribution if they have more than minimal unrealized gains.
  • Potential long-term investors may have a modest incentive to defer investment until the distribution is paid, but only if the Fund’s return during the deferral period is expected to be small.
    Same as what msiebert was actually saying – may want to invest in the fund after the distribution date. At this time of the year, we are only talking about a difference of days. While it is possible to have a significant return in that time, seems unlikely.

SO says it is better to just pay capital gains now while the capital gains tax rate is low, rather than doing the sell/buy thing to avoid paying it now. It has to be paid sometime, and the tax rate probably won’t be as favorable as it is now.