The phrase “getting the hangover without going to the party” can pertain to purchasing mutual funds during the final quarter of a calendar year. And you are asking, huh?? Allow me to elaborate. Mutual funds are required by law to pay out appropriate capital gains and dividends acquired during the year. The estimate for these payments will typically come in a time frame from mid September to November 1. Payments will then occur during the month of December. If you purchase a mutual fund the day before the ex dividend date, you will receive any applicable dividend and capital gain which will be subject to all taxes. Naturally, this applies only to non-qualified accounts as any tax deferred (qualified) retirement account receives the same dividends and cap gains, but is only taxable to the shareholder upon distribution from the account.
If you have been a shareholder in a particular fund since the beginning of the year and continue to be on the “ex-dividend” date definition you will receive a portion of the funds distribution and the appropriate 1099’s will be mailed to you during the first portion of next year. This seems perfectly logical and appropriate to shareholders who have been with the fund for a long period. What doesn’t make sense is for an individual to purchase shares in a mutual fund shortly before the distribution is about to be made. Chances are, they would have not had the benefit of any appreciation (assuming there has been one) and they would receive the negative benefit of having to pay taxes on the distribution. (Please refer back to the first sentence of this post to see the relationship) Remember, the Net Asset Value (NAV) of a mutual fund declines by the amount of the distribution so purchasing the day AFTER the ex-dividend date allows for purchase at a cheaper price per share without having to worry about any taxable event.
Once September is upon us, I would be cautious about making large lump sum investments into non-qualified mutual funds because of this potential taxable event. One strategy is to “park” any invest able assets in another fund, which, for various reasons, may not be paying any distributions, and transferring to the fund of your choice once the ex-dividend date has been reached.