Judging from the traffic numbers to our How Mutual Funds Work - Capital Gains article, there are a whole lot of you out there confused by the tax implications of mutual fund ownership. And why shouldn't you be - mutual fund capital gains can be a perplexing bit of financial folderol that unfortunately is a necessary evil of fund ownership.
About.com has a piece that does its best to clear things up, including this bit that tries to explain how a mutual fund taxable gain distribution affects the value of your fund investment:
The short answer is it doesn't. The NAV [Net Asset Value or fund price] 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 A was 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."
If you didn't choose to have your capital gains distribution reinvested, you would receive a check from the fund company for the distribution amount. When you receive a check, the amount of shares you owned in the fund will not change and your account value should fall by the amount of the check (assuming no changes in the value of the portfolio investments). If you reinvest your fund distributions, the fund company will buy you more shares of the same fund at a lower price. In such a case your share total goes up but your account value remains the same because the fund price fell by the amount of the distribution.
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See also:
How Mutual Funds Work - Capital Gains
Ask MAX: Did My Fund Fall 41% In One Day?
Ask MAX: Capital Gains Quickies
