Opinion: I just received a huge dividend from a mutual fund and the value of my investment fell – what’s going on?
Q .: I just received a dividend of $ 7,000 from a mutual fund that usually pays only small dividends and is now only worth about $ 62,000. At first I thought it was great, but the fund’s price has come down (it was close to $ 70,000 last month) and now I wonder what happened. Can you enlighten us?
–Tom to Akron
A.: Tom, I can try.
First, each time a stock or fund pays a dividend, the value of the holding is adjusted downward. Suppose you gave a coworker $ 1, your net worth just went down $ 1. The same thing happens when a company pays a dividend. It takes money and pays it to shareholders and its value drops by the same amount.
Here’s how it works using a hypothetical example. There are three key dates: the registration date, the ex-dividend date and the pay date. The company says it will pay a dividend of $ 1 to anyone who owns its shares on March 31. This is the recording date. The exchange then determines the ex-dividend date, usually the day before the record date. On the ex-dividend date, if the stock had traded at $ 100 per share, the price becomes $ 99 to reflect the $ 1 in cash that will be paid to those who owned the stock on March 31. The payment date is the date the money is disbursed.
You received a distribution of $ 7,000 and the fund lost $ 7,000, which is the basic mechanism I just described. $ 7,000 is a lot and unusual, so I suspect this is not a standard dividend but a capital gains distribution.
By law, mutual funds must pass the net profits from their transactions for the year to their investors in the form of a distribution. It is common for funds to see net gains on trading after a sharp rise in the markets. It’s also common for gains to be triggered often in volatile years like 2020, when people flee the market, forcing fund managers to sell stocks to deal with buybacks.
Read more retirement news and tips on MarketWatch
These capital gains distributions do not create any tax issues in IRAs, Roth IRAs, or tax-deferred pension plans, but if these distributions are in taxable accounts, you will report the $ 7,000 on Schedule D and pay applicable taxes. The distribution will be coded as short or long term depending on the length of time the securities are held by the fund. You pay regular rates on short-term gains and long-term capital gains rates on long-term gains.
This is the time of year when these distributions are usually made. Most fund families have published record dates, ex-dividend dates, payment dates and estimates of capital gains distribution amounts. If you have large holdings in a taxable account, or intend to purchase a fund soon, it is recommended that you review these potential payments so that there are no surprises when you file your return. of income.
For many people, having capital gains taxed when they don’t proactively sell a stake is inconvenient and, in some cases, costly. This additional gain may increase the adjusted gross income or the modified adjusted gross income, resulting in additional taxes or costs.
If this were the case for you, you are not helpless. It may be possible to build your taxable assets in a more tax efficient manner. Funds that don’t trade as often are said to have lower “turnover” and tend to have lower payouts. Plain-vanilla index funds are a good example. Some fund management teams are very sensitive to these distributions and actively manage tax accounting when trading. These often use the nickname “fiscal management”. You can also use exchange traded funds which, unless something great like leverage, are more tax efficient because of their structure.
If you have a question for Dan, please send him an email with “MarketWatch Q&A” on the subject line.
Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving clients nationwide from offices in Orlando, Melbourne and Tampa, Florida. His comments are for informational purposes only and do not substitute for personalized advice. Consult your advisor to find out what is best for you. Some questions are edited for brevity.