Don't be alarmed if you look in the newspaper or online and notice that your fund's price, or NAV, has fallen and has the letter "z", "x" or "e" next to it. It doesn't mean your fund lost money for you. It simply means the fund made a distribution. Distributions often confuse people because they reduce the fund's Net Asset Value (NAV) and because they create a taxable event.
Why?
Mutual funds are forced by law to distribute at least 90% of its' realized capital gains and dividend income each year. Late December is the most popular time for a fund company to pay out distributions.
Important Dates:
-
Record Date - This is the official date of when the fund determines which shareholders will receive the distribution.
-
X-Date - This date indicates the day the Fund recognizes the drop in Net Asset Value according to the amount it intends on distributing.
- Distribution Date - This date reflects the day the fund actually pays out the distribution due.
How Does the Distribution Affect the Value of My Account?
The short answer is it doesn't. The NAV will drop by the amount of the distribution. For example:
- To make this example simple, assume that Fund A's stock holdings don't change in value during this period.
- Fund Awas worth $5.60 a share on December 5th (the record date).
- On December 6th, the X-Date in this example, the Fund's stock holdings didn't change in value, but the NAV did drop by $0.05 to $5.55 to reflect the $0.05 per share distribution it intends to pay those share holders who held the fund on the record date.
- On December 7th, the distribution date, the fund pays out the $0.05 per share distribution.
- If your account value was $10,000 at the start of this period, it is worth $10,000 at the end of the period and if you chose to have the mutual funds reinvested, you will still hold $10,000 of Fund A.
This example is simplified because it ignores regular changes to the NAV from stock or bond movements that it holds.
Other Important Details
Many funds will make the X-date and the distribution date the same, meaning they reduce the NAV and pay out the distribution on the same day. From a taxable standpoint, there may be long-term capital gains and short-term capital gains, but this only affects taxable accounts, not 401(k)s, IRAs, Roth IRAs or other non-taxable accounts.
It is generally not advisable to purchase a fund right before it is about to pay a distribution. The reason is because it doesn't matter if you held a fund for three days or 3 years, you will get stuck with the distribution anyways. This could result in a taxable event that you would rather not incur.
Despite a losing year, you could end up paying a capital gains tax. To better understand how, and learn more about mutual fund capital gains, I recommend you read this article that I wrote: Capital Gains or Capital Punishment?
