"But it’s shaping up to be a “not-so-happy capital gains distribution season”
When an investor sells a stock for more than the purchase price, the investor experiences a capital gain (normal people would call it a profit, but let’s stick to some technical terms for a minute).
For example, if you bought Microsoft at $55/share back in on December 31st of 2015 and sold it for $143/share on October 31st of 2019, the capital gain would be about $88.
Mutual funds operate in much the same way, although it gets a little more complicated. When a mutual fund sells a stock for a profit, it too receives a capital gain and is required by law to pay most of the gain to its shareholders in the form of distributions – after deducting the fund’s operating expenses
2019 – Adding Insult to Injury
Many investors looked the other way in 2016 and 2017 when mutual fund capital gains distributions were announced – after all the markets posted double-digit gains in both years. But then 2018 came and mutual fund shareholders were met with capital gains distributions and losses – adding insult to injury.
The reason in simple terms is because stock markets have been advancing for most of the past 10 years and mutual funds held appreciated assets. In addition, investors keep pulling their money out of actively managed equity funds, forcing portfolio managers to sell appreciated assets, and then those distributions are then passed on to shareholders (and often a smaller group of shareholders too, making the capital gains even bigger).
2019 is shaping up to be much like 2016 and 2017, when capital gains distributions are pretty significant. But the fact that equity markets are enjoying very healthy double-digit returns so far this year alleviates some of the sting.
Look at the Estimates
Mutual fund firms usually begin estimating and publishing their capital gain distributions in the fall and then make final distributions before the end of the year. You should know that mutual funds don’t all make distributions on the same day – they just need to do so before December 31st. And to help you keep track of the distributions and whether they are short- or long-term, mutual funds report this information to shareholders on IRS Form 1099-Div after the end of every year. Here is a something that might have you worried though. A quote from mutual fund watchdog Morningstar’s Christine Benz on November 14, 2019: “Brace yourself: 2019 is apt to be another not-so happy capital gains distribution season, with many growth-oriented mutual funds dishing out sizable payouts.”
Implications for You
It is important to discuss the implications of mutual fund investing and taxes with your financial advisor. Generally speaking, if you own a mutual fund in a taxable account and that mutual fund makes a distribution, you’ll owe taxes on the distributed gain (unless you can sell losing positions to offset the gain). But if you own the same fund in a tax-sheltered account, you don’t have to worry about the distribution until you actually begin selling yourself.
Again, talk to your advisor.