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Capital gains distributions
Old 05-21-2006, 08:48 PM   #1
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Capital gains distributions

I heard Suze Orman last night saying that you probably shouldn't buy into a mutual fund close to the time when a fund gives out capital gains distributions.

I don't get it. Are CG distributions basically the dividends from the funds. If you receive a $100 in distributions, you pay a tax on the distribution, right? Aren't you still making money?
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Re: Capital gains distributions
Old 05-21-2006, 09:02 PM   #2
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Re: Capital gains distributions

Well, you don't really make money. After the distribution is made, the share price goes down by exactly the same amount. So, you've paid taxes you wouldn't have had to pay if you'd waited until after the distribution was made to buy the shares.

I don't go crazy tracking this (and never varied my small automatic monthly purchases), but it is generally better to wait a few weeks rather than buy just before distributions are made.
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Re: Capital gains distributions
Old 05-21-2006, 09:04 PM   #3
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Re: Capital gains distributions

Yes, but a capital gains distribution is made because of favorable transactions that the fund manager has made within the fund over the course of the entire year.* These transactions have been reflected in an increase in the net asset value (the per-share value) of the fund.

If you buy a fund just days before the taxable distribution is made then you immediately owe taxes on something for which you haven't benefited from.

You basically are getting some of the investment you just made *handed back to you along with a tax bill.
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Re: Capital gains distributions
Old 05-21-2006, 09:06 PM   #4
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Re: Capital gains distributions

Virginia,

No, the capital gains distributions by a fund are different than the dividend distributions. During the year the fund sells shares of stocks that have been held by the fund. If the fund sells the shares for more than it paid for them, then the fund has a capital gain. Near the end of the year (more often for some funds) the fund will distribute those capital gains to the holders of shares of the fund. On that date the net asset value (NAV) of the fund goes down by the amount of the capital gain distribution. So, it you buy shares of a fund for $10 a share the day before a capital gain distribution and the fund distributes $1 in capital gains, then the NAV goes down to $9 and you have to pay income tax on the $1 of distributed gain. If you wait til the day after the capital gain distribution to buy shares of the fund, you only pay $9 per share and have no immediate tax liability.

I hope that helps.

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Re: Capital gains distributions
Old 05-21-2006, 09:09 PM   #5
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Re: Capital gains distributions

Ok - so, my question - part two

I am going to invest about $100k (from home sale) into the Janus Contrarian Fund. Should I be concerned with the capital gain distribution? I'd have to check with the fund company, but I believe that distributions are in November.

Thanks for your help.
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Re: Capital gains distributions
Old 05-21-2006, 09:24 PM   #6
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Re: Capital gains distributions

If the distrbutions are really in November, then I wouldn't be concerned about investing right now.

Can I ask why you selected this fund? Does it play a particular role in your portfolio that is worth the .93 expense ratio? That ER isn't crazy, but it's more than some other choices.
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Re: Capital gains distributions
Old 05-21-2006, 09:42 PM   #7
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Re: Capital gains distributions

I chose that one, only because it's already a fund that I have in my IRA, and has returned well in the past couple of years. It also has a five star rating by Morningstar.
I'm no expert on funds, so if you have any recommendations, I'd love to check them out. I'm not chained to the idea of this particular fund.
I'm also considering putting the money into two different funds, not putting all my eggs in one basket. I just need to make a decision in the next couple of weeks, or it's gonna be sitting around in a savings account.
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Re: Capital gains distributions
Old 05-21-2006, 09:47 PM   #8
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Re: Capital gains distributions

Virginia,

Regardless of the fund(s) you choose, may I make a suggestion since the money you are going to invest isn't already in the stock market, that you Dollar Cost Average. *That is, spread out your investments into equal monthly portions over a span of maybe a year or two. *That way, you'll buy more shares when the price is low, and fewer when the price is high. *It's the same principle that is followed for 401K, etc. investing.

If you were to dump $100K in the market at one time, you are increasing your risk if the market were to drop significantly.
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Re: Capital gains distributions
Old 05-21-2006, 10:04 PM   #9
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Re: Capital gains distributions

Quote:
Originally Posted by gindie
Virginia,

Regardless of the fund(s) you choose, may I make a suggestion since the money you are going to invest isn't already in the stock market, that you Dollar Cost Average.
This is good advice. You should be able to find a money market acct. paying 4.5% or so and use that as a place to park your funds while you DCA into your chosen equity fund(s).

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Re: Capital gains distributions
Old 05-21-2006, 10:33 PM   #10
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Re: Capital gains distributions

Virginia,

- I don't have a specific fund to recommend, I don't know anything about the Contrarian fund except what I just read on Morningstar. But, your idea of allocating your eggs into different baskets to help protect against risk is generally a good idea. As you know, there are lots of asset types out there (foreign stocks, small US stocks, "value stocks", "growth stocks", bonds, etc). All of these have risks, but often some are going up while others go down. If you concentrate in a single category (large US stocks, which is what Contraian Fund holds) you may do great--but you may also take a bigger decline than you need to.

You might consider adding a fund that has exposure to different types of assets since you already have some holdings in Contrarian Fund. In addition, you might look for a fund with low costs--again, this fund doesn't have exceptionally high costs, but many index funds can be bought that have expenses less than .2 per year. The 3/4ths of one percent difference may not sound like a lot, but it is $750 in your case in the very first year--and every year thereafter. Plus, you lose the compounding of that extra money that is taken out---over several decades this is HUGE.

If my sister said she wanted to invest $100K within the next few weeks and didn't have a firm idea of how she wanted to allocate her assets for the long haul, I'd tell her to put it all into the Vanguard Targeted Retirement Fund for the year closest to the year she'd start needing the money (e.g Target Retirement 2045). This fund is already balanced across a lot of asset classes US stocks, foreign stocks, bonds, etc). There's no "perfect fund" but this a low-cost fund and would give her time to learn more before she commits to something else. And, if she never touched it until retirement I think she'd still be well ahead of 90% of her peers.

gindie's dollar cost averaging idea is advocated by a lot of folks. This assures that you don't jump into the market with al your money just before it takes a dive, and if the market goes up and down you'll be buying more shares when they are cheaper. If this helps you feel better about the investment, then do it. While studies have shown that investors do slightly better, on average, by having their money in the market rather than investing it slowly over a long time, that's strictly an average (and won't make you feel much better if the market tanks the day after you invest your money). Again, if it were my sister I'd recommend that she buy in all at once rather DCA. If she wanted to DCA, I'd recommend she do it over approx 6 months rather than be out of the market for longer. The right answer on this lump-sum vs DCA thing won't be known except in retrospect, do what makes you most comfortable.

-I'm assuming you've already done the other smart stuff--paid off high-cost credit balances, you're already taking full advantage of any company match you might have in a 401k, TSP, 403B, etc. I'd do those things first, then an IRA, then non-tax deferred investing.


Best of luck!
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Re: Capital gains distributions
Old 05-22-2006, 08:23 AM   #11
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Re: Capital gains distributions

Virginia,

If you are going to follow the excellent advice already given to dollar cost average into several funds there is an easy way to set this up. Most fund families will let you put the money into one of their money market funds and establish automatic monthly transfers into one or more of their other funds. Just decide on the monthly amounts and the funds you want and the rest is taken care of for you. I used this method with Vanguard and it was a snap.

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Re: Capital gains distributions
Old 05-23-2006, 12:16 AM   #12
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Re: Capital gains distributions

Thanks everyone -

My deal with this money is that I'm not sure how long it will be invested - possibly at the most under 3 years. This is money that I've made off my home, and I plan to buy again in the next 2-5 years, but don't know exactly when.

But wow - I just hadn't thought about how much that expense fee would be. I should have been more thoughtful about that.
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Re: Capital gains distributions
Old 05-23-2006, 05:34 AM   #13
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Re: Capital gains distributions

virginia,
- If you'll need the money within three years, I think you should reconsider whether it belongs in stocks at all. I think most folks would recommend that you steer clear of equities for short-term savings needs. While stocks always go up over long periods, sometimes they dip and don't come back for a long time (a decade). If I knew I'd need the money within 36 months and would like to be able to get it quickly in order to snap up a good deal on a house, I'd probably park it in a money market account, take my 3-5% per year, and not worry that some short-term decline in the stock market was going to cost me $10-25k just when I needed the money..


Best of luck!
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Re: Capital gains distributions
Old 05-23-2006, 09:20 AM   #14
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Re: Capital gains distributions

Virginia,

Absolutely, do not put $100K of money you may need in three years or less into an equity mutual fund. You stand a significant chance of only having $75K or less when you need it (markets do go down and stay down for many years). Use a money market fund or a short term CD.

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Re: Capital gains distributions
Old 05-23-2006, 10:40 PM   #15
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Re: Capital gains distributions

I knew you guys were gonna say that
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