Timing May Be Everything

Mutual funds provide an attractive investment vehicle for nearly all types of investors by offering diversification, flexible investment choice, professional management and easy access to your money. These attributes make mutual funds appropriate for many financial plans. Consequently, the volume of investment in these companies has skyrocketed. However, mutual fund investors should consider the timing of their purchases to avoid a possible tax trap.

Mutual funds accumulate ordinary income and capital gains, which are reflected in the fund's net asset value. Generally, net asset value refers to the dollar value of one share of the fund's stock. The funds eventually distribute these accumulated capital gains and income in the form of dividends on a yearly basis. These dividends can be reinvested automatically to purchase more shares or they can be paid directly to the shareholder. The net asset value drops correspondingly to reflect these distributions.

The problem of timing occurs for those investors who make purchases right before a distribution. These purchasers may end up paying tax on money they just put into the fund, a painful tax bite especially for first-time shareholders.

Consider a first-time investor who purchases $20,000 worth of mutual fund shares at $10 per share the day before the "record date." The fund has accumulated undistributed long-term capital gain of $2 per share and declares a $2 distribution per share in August of 1998 to holders of record on the record date. The investor may receive a check for $4,000 or may reinvest these dividends. Either way, the investor must report this distribution as a long-term capital gain on his or her tax return. If the investor is in the 28% bracket, he or she is now on the hook for $800 in taxes for shares that may have been held for one day. Were the investor in a higher tax bracket and the distribution was short-term gain or an ordinary dividend, the taxes would be higher.

Avoiding this tax hit depends upon the timing of your purchases. Find out when your respective fund makes its yearly distribution. For most funds' stock, it's in December. Consider waiting beyond "record date" until the "ex-dividend date." As the net asset value drops to reflect the distribution, the shares will also be cheaper.

This tax bite doesn't apply to investors buying fund shares for a tax-deferred retirement plan. Further, you should never delay your investment decisions solely because of the tax considerations.

If you would like to find out more, please give me a call at (315) 363-3338.

Very truly yours,

G. William Hatfield
Certified Public Accountant
Certified Financial Planner