Blog Article

Investing around mutual fund distributions

Lowell Parker

By Lowell Parker, Wealth Advisor CFP®
Published On 11/15/2010

I have liquid assets that I want to invest in Vanguard Funds using your diversification strategy. Many of the funds pay out dividends at the end of December. My money is sitting in the bank right now. Is it better to wait until January to invest after the dividends are paid, or is now far enough ahead that the dividends won’t create a penalty?



If your time frame is from now to the end of the year, there is no way to know now whether you should invest at all. If markets go down between now and December 31, you are better off with money in the bank. If markets go up, you are better off investing.

If you are a long-term investor with a view out some years in the future, then the real issue is whether your cost will be lower now or after December 31. There again, there is no way to know. The swings of the market are likely to have a much bigger effect on this than the tax consequences of “buying” taxable dividends.

If you are willing to ignore possible price changes between now and the end of December, then you can focus on the effect of paying taxes on dividends. Of course, this is only relevant for taxable accounts. For tax-deferred accounts such as IRAs, taxation of distributions is a moot point.

You can’t know in advance exactly how much a fund will distribute. However, if you assume distributions of 3% that will be taxed at a rate of 15%, your tax bill on a $100,000 investment would be $450. That’s 0.45 percent of the investment, a bit less than one half of one percent.

You may be able to learn that the distributions will likely be higher or lower than that, and you might want to postpone investing in those funds with a high expected payout until after the distributions.

However, with approximately two months to go before distributions are likely, I think you need to see this in proper perspective. What might you be giving up in order to reduce your buying costs by one half of one percent? Many times, the market goes up or down more than that in a single day. So how much does it pay to worry about a tax consequence that is essentially no more important than the “noise” of the daily or weekly market creaking back and forth?

So what is the answer? Our rule of thumb is to use mid-November as the cutoff point for investing in funds with expected year-end distributions. The long-term direction of the market is upward, and it doesn’t make sense to remain on the sidelines for long just to avoid a 0.5% cost. In the end, it comes down to this: The short-term future is impossible to predict, and you simply have to make your choice and live with the results. If you are truly a long-term buy-and-hold investor, a 0.5% bump in your cost will not make or break your retirement.

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Lowell Parker

By Lowell Parker, Wealth Advisor CFP®

Lowell developed a passion for finance in high school, after some hard lessons learned. Now as a Wealth Advisor, he appreciates the opportunity to help his clients articulate, achieve, and expand on their financial and associated life goals. He particularly enjoys working with mid-career technology professionals.

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