Mutual Fund purchase and distributions (taxes)

[jeromedawg]

Hey all,

So I'm pretty sure I made the costly mistake of buying mutual funds prior to the distribution (in December) at the time not realizing this pitfall. I checked and it looks like the distribution schedule is April and December for one fund. Makes sense cause I think I purchased pretty large sums in mid/late-November and mid-December or so and got a bunch of dividends soon after. In either case, everyone says, in most cases, make sure to buy *after* the distribution. But what exactly does that mean? Does it mean you buy the fund immediately the day, week, or month after the distribution? Or, to put it another way, how long *before* a distribution is it 'safe' to buy a fund without having to worry about getting a big distribution (e.g. I purchased some funds on 11/21 and got large distributions on 12/17). What is the window to do this in order to avoid the additional taxation moving forward?


 

[skyrefuge]

This is called "buying the dividend", and Vanguard has a good summary/example of it: https://personal.vanguard.com/us/insights/taxcenter/buying-selling-mutual-funds

For your situation, I think the most-important paragraph is the last:

"To avoid buying a dividend and having to pay current tax on it, check a fund's distribution schedule before you invest. Keep this in perspective, though: This rule of thumb primarily applies to large lump-sum investments. So evaluate both the size of your investment and the size of the fund's impending distribution before deciding to hold off buying until after the record date. If the amount you're investing is fairly small, it may not be worth waiting. And if you make regular investments every month, don't let buying the dividend derail your program. It's better to buy the dividend than to fail to invest." (emphasis added)

If "pretty large sums" was some double-digit percentage of your net worth, then maybe it would have been more optimal to wait a few weeks, but it's not really worth beating yourself up over it. In general, "large lump-sum" investments is something that will almost never happen in your investing life going forward (because you'll be regularly investing money as you get it). So unless you sell a house or get an inheritance or something, there's no need to worry about the distribution dates on the funds you're buying.

[TheOldestYoungMan]

I dump as much as I can into my portfolio every paycheck, so every year I end up with a little bit of short term capital gains from dividends from mutual funds bought in that calendar year in addition to a growing amount of long term capital gains from dividends from shares I bought in years past.  So far it just hasn't been enough in taxes to worry about.  I honestly am annoyed more by having to fill out the forms then I am by paying the money.  First world problems right.

Some funds deal in weird stuff and have non-qualified distributions regardless of how long you've held the fund, so you get to pay taxes on those like ordinary income too.  For a taxable account you therefore want to pay attention to that after-tax yield on the info sheet.


I'm only in for about 150k invested at this point, only around 22k was purchased within the last year (in taxable accounts) and choose funds that are low on the dividend payout, so maybe it matters more if you've got bigger quantities/different funds.

I still wouldn't think of it as a mistake though.  If you think of the invested dollars like employees and the taxes like overhead, there's probably more risk in waiting to put someone to work to slightly reduce overhead than there is in putting them to work right away and paying the extra overhead.  I'm also suspicious that if you managed to buy a fund that paid out only once a year, and you bought it the instant after that payout happened, you're going to get hit with a non-qualified distribution the next year when it pays out.  I *think* it's unavoidable.

It ends up being a similar discussion to the, should I lump sum invest or dollar cost average?
https://pressroom.vanguard.com/content/nonindexed/7.23.2012_Dollar-cost_Averaging.pdf

The market will do what it will do, the IRS is going to get it's cut, save all you can.

Good luck!

[jeromedawg]

Thanks all for the tips! I think this is part of the reason why I held back on selling off *all* my stuff initially. I guess there's never a perfect time to buy in the sense of 'avoiding' the distributions at the end of the day. I still have quite a bit in a couple funds that have gained over 100% since I've had them gifted to me from my dad. And I have another good amount worth in stocks sitting in Scottrade that I really need to reinvest as well. I didn't want to do it all last year to avoid getting hit with crazy cap gains. My current taxes are already pretty high as it is ($7k) so I think if I had sold everything else before year-end it would have looked even uglier. So I think I'll have to consider selling soon and reinvesting in the various Spartan Indices I've already gone into. Taxes for this year aren't going to look too pretty either with all of this movement. Wish I had realized and knew about all this stuff way earlier than now :(