By Frank Jersey
General Manager for 2050 Systems, LLC.,
2020 Systems, LLC

fjersey[at]someonesgottadoit.com
www.someonesgottadoit.com

© 2005 By Frank Jersey

Many Mutual Funds declare dividends and gains from time to time. It is important to understand how these activities affect the investor and the Mutual Fund price. Over time, the investments made within a Mutual Fund declare dividends, short-term gains/losses and long-term gains/losses. Dividend distributions are called "income distributions" and are usually paid out twice a year. Distributions resulting from sales of underlying investments by the Mutual Fund are called "capital gain distributions" and are usually paid out once a year. The Mutual Fund accumulates the results of these activities and from time to time will declare the results and pass the results on to the investors. Not all Mutual Funds do this, but many do. Also, while a fair number of Mutual Funds declare dividends twice a year and gains at the end of the fourth quarter each year, the Mutual Funds can declare the results for dividends and/or gains at any time throughout the year.

During the period where the Mutual Fund is accumulating the activities resulting from the investments made within the Mutual Fund, the Mutual Fund price will rise and fall reflecting the impact of the underlying investments along with any activities passed on to the Mutual Fund resulting from dividends and gains/losses passed on from the underlying investments. This is important to understand because when the Mutual Fund pays a dividend and/or gain/loss, the Mutual Fund price will be affected by the disbursement. The fluctuation in Mutual Fund price happens because the Mutual Fund actually pays out funds reducing the overall value of the Mutual Fund.

If an investor were to purchase a Mutual Fund just prior to the ex-dividend date for the dividends and/or gains, then the investor would receive the investors' portion of those dividends and/or gains appropriate for the investors' shares in the Mutual Fund. This distribution could create a taxable event for the investor if the investor account is a regular account and not a deferred account such as an individual retirement account (IRA) or 401(k). If the distribution is considered taxable, then the investor could owe Federal and possibly State taxes on the distribution and these taxes must be paid in the current tax year. If the investor has chosen the "reinvestment option" for dividends and/or gains, then the investor must come up with the funds to pay for the taxes. If the investor has requested that dividends and/or gains be paid to the investor, then the disbursement will be made to the investor making funds available from the disbursement to pay the taxable portion.

An investor who has elected to reinvest dividends and/or gains would have additional shares of the Mutual Fund purchased. While the Mutual Fund price would drop reflecting the declaration of dividends and/or gains, the purchase of additional shares would leave the investor with the same relative account value as existed prior to the declaration subject to any fluctuations not resulting from the dividends and/or gains.

If an investor makes a purchase just after the ex-dividend date and the Mutual Fund has declared dividends and/or gains, then the investor would benefit from the reduction in Mutual Fund price and purchase more shares of the Mutual Fund than would have been purchased had the purchase been made just prior to the ex-dividend date for the Mutual Fund. Many experts suggest that investors be aware of the "ex-dividend date" and "date of record" of a Mutual Fund and if the ex-dividend date is approaching, hold off until after the ex-dividend date to make an investment in the Mutual Fund.

Likewise, when selling a Mutual Fund, an investor might want to be aware of the ex-dividend date in order to take into account the tax considerations of such a sale. Since the Mutual Fund price will fluctuate as a result of the declaration, it stands to reason that a sale just prior to the ex-dividend declaration date can create different tax consequences for a portion of the investors account value by timing the sale to be just prior to the ex-dividend date. If the investor held the Mutual Fund for more than twelve months, then the entire sale will be considered long-term gain and taxed accordingly. If the same account were to be held until just after the ex-dividend date and sold, then any distributions declared would have to be taxed according to the declaration as dividends, short-term gains and long-term gains. Both dividends and short-term gains are taxed as ordinary income and in most instances at a higher rate than are long-term gains taxed. If an investor had a significant account value and if the declaration were of significant value for dividends and/or short-term gains, the tax consequences might be significant.

An investor account will reflect declared dividends and/or gains according to the options selected by the investor. To find out what options have been elected, the investor just has to call the Mutual Fund customer service department or in most cases can look up the account online. If fluctuations for non-dividends and/or gains are removed from an account, the overall account value will remain about the same. The tax consequences might be different, but the overall value will be about the same. An investor who feels uncomfortable making a purchase or sale of a Mutual Fund due to dividend and/or gains consequences can call the Mutual Fund customer service department and discuss the concerns with a Mutual Fund representative. If the investor has an advisor, it might be worthwhile consulting that advisor prior to making a Mutual Fund purchase or sale due to the consequences that may occur.

__________________________________________________________

Mr. Jersey is the General Manager for 2050 Systems, LLC. 2020 Systems, LLC is a provider of Income Management Applications Software for Consumers. For more information visit www.2050systems.com or visit Mr. Jersey's retirement information site at www.someonesgottadoit.com.

Published - January 2006