Choosing A Good Day To Buy A Mutual FundDec 5, 2012
By Staff writer State Farm™ Employee
One of the advantages of investing in a mutual fund is that you can buy or redeem shares any day that the market is open. You can invest on your schedule, when you have the funds and the time to make a financial decision.
However, there are a handful of days when you probably shouldn’t make an investment. These are the days immediately before a fund is about to make a dividend or capital gains payment, or distribution, to fund investors. Make an investment then, and you’ll be purchasing some taxable income along with your shares.
Dividends And Distributions
Here’s an example. Investor A and Investor B both want to put $10,000 into a mutual fund that will pay out a distribution of $1.50 per share on December 15. Investor A places an order on December 14. The net asset value of a share is $50, so he receives 200 shares. On December 15, the distribution is made, which reduces the value of a share to $48.50. Investor A receives $300 in dividend income or capital gain that is reinvested in the fund. Investor A's original shares are now worth $9,700 ($48.50 x 200), and the reinvested dividend purchases 6.186 additional shares ($300 ÷ 48.50). Investor A now has 206.186 shares and taxable income of $300.
Investor B knew about the distribution and waited until December 15 to buy the shares. Her $10,000 purchased 206.186 shares (10,000 ÷ 48.50), the same as Investor A. She has not received any dividends or capital, so there are no taxes assessed.
The tax issue is not a concern for investors buying shares in a qualified retirement plan such as an IRA; taxes on these accounts are deferred until retirement and are based on the value at the time of withdrawal.
Most funds make their distributions before the end of the calendar year, so you are more likely to run into this problem in December than in January. The best way to avoid this is to check with the mutual fund company to find out the distribution date. A quick phone call could save you money at tax time.
Buying a dividend isn’t the only potential mutual fund taxable event that can be avoided by looking at the calendar. Another is the wash sale rule, which can affect people who actively transfer money among mutual funds.
A wash sale occurs when you sell a share of a mutual fund or other investment for less than you bought it for, then repurchase shares in the same investment or one that is substantially the same within 30 calendar days before or after you made the sale. The IRS doesn’t want you to make a trade just to get the tax loss, so they will not allow you to use it to reduce your tax liabilities.
You are allowed to add the wash sale loss to the price you paid for the securities (known as the basis), so you may be able to receive some tax benefits in the future when you sell the entire position.
If you are aware of these rules, you may be able to avoid expensive mistakes. Although mutual funds trade every day that the stock market is open, sometimes it makes sense to wait.
Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact State Farm VP Management Corp (1-800-447-4930) for a prospectus or summary prospectus containing this and other information. Read it carefully.
Net Asset Value (NAV) is calculated by adding all of the assets of a Fund, subtracting the Fund’s liabilities, then dividing by the number of outstanding shares.
Securities are not FDIC insured, are not bank guaranteed, and are subject to investment risk, including possible loss of principal.
A 10 percent tax penalty may apply for withdrawals from tax-qualified products before age 59˝.
Investment return and principal value will fluctuate and your investment, when redeemed, may be worth more or less than its original cost.
State Farm Agents do not provide tax, legal, or investment advice.