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Now May Not Be The Best Time For Lump-Sum Equity Fund Investing...

Now May Not Be The Best Time For Lump-Sum Equity Fund Investing...

| November 12, 2019
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This is the time of the year when investing lump sums into equity mutual funds may not be your best practice.

First some basics…

Fund managers, particularly stock (equity) fund managers, try to buy low and sell high. They buy a stock at one price, sell at a higher price, and the difference is their profit.

An “Unrealized Gain” is when a stock is purchased at one price, and value goes up. There’s a gain on it, but since the manager hasn’t sold that stock, the gain isn’t locked in. It’s considered “Unrealized”.

A “Realized Gain” is if the manager purchases that same stock, the value goes up, and he or she sells that stock. Now, you’ve “realized” the gain. You’ve locked it in.

Simply put, those gains stay in that mutual fund, and because of that growth, your share value goes up.

However…. Unless your fund is in an IRA, ROTH IRA, or other tax deferred investment, those realized gains get “declared” at the end of the year, which basically means the fund manager lops off the “realized” gains from the fund assets, and distributes them to you in the form of either an income check or reinvested into more shares. And because they distribute those gains, and give them to you, the share price goes down.

Imagine it this way…. Your $100.00 investment gets you 10 shares at $10.00 per share. The price goes up to $20.00 per share, so your investment is now worth $200.00. Your manager wants to lock in those gains so he or she sells those shares, and takes your $200.00 and purchases 20 shares in a new stock for $10.00 per share. You still have the same amount of value that you had before the sale… $200.00. However…. because your manager sold your old shares for a $100.00 profit, and at the end of the year, declared that distribution as a realized gain, you owe taxes on that gain.

So here’s why purchasing shares of a stock mutual fund near the end of the year is not always the best thing you can do for yourself…

It’s now November. All year, the stocks inside a mutual fund have presumably been rising in value. If you invest your lump sum now, just prior to the manager declaring the realized gain and making the distribution, you will not have participated in that rise in value, but you ARE going to participate in paying taxes on the distribution of the realized gain.

So you’re going to invest your lump sum, it’s done growing for the year, the manager is going to distribute the gains, the share price will drop, and you’ll have your capital gains (that you didn’t really participate in the growth of) reinvested into additional shares. You’ll still have the same investment value, but now… you’ll owe taxes on the realized capital gain distribution.

If you’re contemplating a lump sum investment into a mutual fund this late in the year, it might be advantageous to wait till the fund you want to purchase has already declared and distributed its’ capital gains.

The above isn’t necessarily as true for ETF’s, bond funds, or funds with low turnover, but for funds whose primary focus is to grow from the rise in share value with active management, this could be something important to keep in mind.

And, as always, if you have any questions, always feel free to call or write.

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