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SOME MUTUAL FUND
This is the time of year when most mutual funds distribute money to their shareholders for the capital gains that the fund has realized during the year.
Most mutual fund investors reinvest those distributions to buy more shares rather than use them to cover their capital gains bill. On the day the capital gains are distributed, the price of the fund will drop by that same dollar amount.
Some mutual funds won't have any capital gains this year because of the stock market's terrible performance. But many funds will. Shareholders of those funds are therefore left with the distasteful likelihood that they'll be hit with a tax bill despite the fund's price dropping during the year.
Part of the reason for that is some mutual funds have been forced to sell stocks this year to generate cash for spooked shareholders wanting out of the market. Many managers won't want to sell undervalued stocks that have greatly underperformed. So they may have sold stocks that have held up better, which could lead to capital gains distributions.
Long-term capital gains distributions from mutual funds are treated the same as long-term capital gains on individual stocks. Short-term distributions are taxed as an ordinary dividend.
Investors can do a couple of things to lessen the bite of capital gains from losing mutual funds.
First, they can take capital losses on individually owned stocks to offset the long-term capital gains from mutual funds.
Second, investors can check their mutual funds' Web sites to see when the gains will be distributed. Investors might consider holding off buying any new shares until the fund makes its distributions--unless you have a strong belief that the prices will rally sharply over the next few weeks.
One final thing to keep in mind--this is only applicable to people who own mutual funds in taxable accounts. Mutual fund distributions don't affect tax-exempt accounts such as IRAs and 401(k)s.
Fool me once
Michael Mauboussin, chief investment strategist at Legg Mason Capital Management, is an insightful thinker on the market.
His excellent book--"More Than You Know: Finding Financial Wisdom in Unconventional Places"--combines lessons from psychology and numerous disciplines to shed light on the markets and investors.
In an Oct. 29 strategy piece titled "Long-Term Opportunities Amidst the Fear," Mauboussin lays out the case for why the stock market now offers bargains for long-term investors.
The market has returned zero gains over the past decade. Over the past century, the market has bottomed out during 10-year rolling periods of zero-percent returns--such as the 1930s and 1970s.
Mauboussin said the massive efforts by governments around the world to restore the financial system will ward off another Great Depression and make the downturn more along the lines of those in the early 1970s, 1980s and 1990s.
But few people will take advantage, behavioral finance shows. Mauboussin gives this example of a study that shows why:
Normal people were pitted against people with brain damage in a contest. Each participant was given $20, and for 20 rounds had to either keep their dollar or hand the dollar to the researcher who then flipped a coin. Contestants were paid $2.50 for a win and zero for a loss. So the expected value of handing over the dollar was $1.25. The brain-damaged participants ended up with 13 percent more money.
The reason? Both groups started out playing every round. But the normal people often sat out a round or two after losing, too stung by the loss to continue playing a game with highly favorable odds. The other group played every round.
Mauboussin makes the case that this same mentality prevails in the stock market. People who have been burned once don't want to lose again, even if they know there is value in the market. His advice? Set your emotions aside and do what makes rational sense.
You can find a link to Mauboussin's report on my blog: Fredericksburg.com/blogs/bizbrowser.
Staff reporter Bill Freehling writes this weekly column on business, personal finance and investing. He can be reached at 540/374-5405 or
Email: bfreehling@freelancestar.com.
