As I was traipsing through our discussion boards the other day, I ran across a bunch of alarmed investors on our Mutual Funds board. They were asking similar questions:
- WaxTadpole: "One of my mutual funds -- Fidelity Capital Appreciation
(FUND:FDCAX), a large-cap growth fund -- just dropped 5% on a day when the broader market was up. I thought this was extremely unusual. I've been holding the fund for about a year and have never seen any movement like this up or down. Am I missing something? Or do you think this is just normal fluctuation?"
- Jaimelesbonbons: "Does anyone own or know what's going on with Delaware Emerging Markets
(FUND:DEMAX)today? It dropped 37%..."
- TrailerParkJawa: "Dreyfus Appreciation
(FUND:DGAGX)-- What happened? ... the mutual fund fell something like 5% yesterday?? There is no associated news, the markets didn't implode in a fury of carnage, is this a mistake of some sort? I've had this mutual fund for a long time and don't ever remember it moving up or down that much in a day."
The answer was the same for each of them: It's the time of the year when many mutual funds make dividend and capital gains distributions. (As Jaimelesbonbons explained in a follow-up post: "Called them. You are right on. It's a dividend and capital gain. Thanks guys!")
Let's back up a bit, though. You know that funds will buy and sell various holdings throughout the year. And you know that many funds hold dividend-paying stocks, too. Well, as a shareholder, you're entitled to a piece of that dividend pie, and to a portion of capital gains realized when the fund sells shares of winners.
Lest you think that you can run around buying shares of funds before they pay out these sums, and then sell them right after, know that you can't. Fund prices are adjusted downward to account for distributions. (That's why some investors get alarmed when they see that their fund has suddenly lost, say, $5 per share in value, not realizing that they'll be receiving $5 per share from the fund company.)
In fact, it's smart to avoid buying into a fund just before it makes a distribution -- because in such a case, you'll be on the hook for capital gains taxes on holdings you hardly held at all. Instead, call the company of a fund you're planning to invest in and ask when the next distribution will be. Don't buy just before it.
To learn more interesting ins and outs on tax matters related to distributions, click into this discussion on our funds board.
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Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. Fidelity Capital Appreciation is a Champion Funds recommendation. AT&T is a former Stock Advisor pick. The Motley Fool has a full disclosure policy.