About Mutual Funds With High Capital Gains
Mutual funds are required by law to pass along the gains on sale of stocks to shareholders. The funds pay the gains to shareholders in the form of capital gains distributions. Mutual fund investors should be aware of the timing and impact of capital gains.
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Function
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As mutual funds sell securities in the portfolio, they record gains and losses on the transactions. If the gains exceed the losses for the year, the fund is required to pay any net gains to shareholders by the end of the year.
Effects
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If a mutual fund has a good year, and buys and sells a lot of stocks, they might have significant capital gains they must distribute. Most funds make the distribution during the last few weeks of the year, and these distributions represent the profits of the year just ending.
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Significance
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Capital gains distributions are taxable as long- or short-term capital gains based on how long the fund held the securities. Investors who buy shares just before the distribution will have to pay taxes even though they did not participate in the gains.
Effects
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A mutual fund's share price will decrease by the amount of the capital gain distribution on the day it is paid. The capital gains are usually reinvested in new shares so the account value is the same before and after the distribution.
Warning
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Investing in a mutual fund that has done well near the end of the year can result in a large taxable distribution.
Potential
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High capital gains distributions are not an indicator of the future performance of the fund. They are the result of past profits. Do not select funds based on their past capital gains.
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