It would be great if someone could clarify on the below issues (1) Cap Gains Distribution: Most Mutual Fund-distribute most of their realized capital gains at the end of year to avoid paying tax- Is this amount taken into account while calculating the returns of the Mutual Fund. I think that a 5 year returns for a Mutual Fund-would be calculated based on opening and closing NAV-thereby ignoring the distributions, thereby ingoring this. (2) Distribution on pro-rata basis: How is the Cap Gains Distribution done among the investors-is it based on amount of units held by each investor. So if an investor holds 100 units and there are 1000 units in the fund- would he get 10% of the total Cap Gains Distributions. If that is the case- why do investment websites, advise against buying Mutual Fund-before a Cap Gains Distribution is about to take place?
I’ve never seen a mutual fund return calculation that did NOT take into account these distributions, but it is something to watch out for. After all, newspapers regularly run return calculations of the major stock indices that ignore dividends. Usually, however, mutual fund returns are calculated by industry professionals, like Morningstar, and they do remember to take distributions into account. Most mutual funds also post regular income distributions as well, representing dividend (in the case of stocks) or coupon income (in the case of bond mutual funds). Then you also have the special case of money market mutual funds, with a constant NAV of $1. Their return would always be 0% if you ignored income distributions. You understand the pro-rata distribution just fine. But at level 3, I would think the implications are obvious. First of all, the value of the shares held will drop by the amount of the distribution. Net Asset Value will go down when the mutual funds pays out this money, right? And you, the shareholder, will now have to pay taxes on this money that is simply being given back to you. So if you buy a mutual fund share at $10 and two weeks later it pays a $1 capital gain distribution, you will now own a mutual fund share worth only $9 (assuming underlying prices don’t change), and you will have $1 in cash… PLUS you will owe the government taxes on the $1 distribution.
That is the perverted world of mutual funds You can have a loss on your mutual fund holdings but still be required to pay tax on the capital gains realized inside the mutual fund. Also you can hold long term a mutual fund and still have to pay taxes on capital gains- there goes your tax efficiency of mutual funds - ETFs are better in a lot of ways but still not perfect. Anyways if you separate the two taxable events that are related to buying and selling mutual funds you will have x different scenarios. 1. there is a taxable event created by buying and selling the mutual fund units 2. there is a taxable event when the fund buys and sells a holding because these are passed on to the holder of record around the time of distribution
But you also have a higher cost basis, reducing future capital gains. It’s a deferred benefit, but a benefit nonetheless. plyon Wrote: ------------------------------------------------------- And you, the > So > if you buy a mutual fund share at $10 and two > weeks later it pays a $1 capital gain > distribution, you will now own a mutual fund share > worth only $9 (assuming underlying prices don’t > change), and you will have $1 in cash… PLUS you > will owe the government taxes on the $1 > distribution.