question about "avoid buying the dividend"

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hudson4351
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question about "avoid buying the dividend"

Post by hudson4351 » Wed Oct 22, 2014 11:23 am

I am about to open my first taxable investing account and have been researching the issues unique to taxable accounts. One piece of advice I have found is to "avoid buying the dividend":

https://personal.vanguard.com/us/insigh ... tual-funds
http://www.fool.com/foolu/askfoolu/2003 ... 030701.htm

The two articles above advise investors to not make a large purchase of a mutual fund right before a dividend is paid out in order to avoid taxes. My question is: assuming dividends are paid out quarterly, what difference does it make if you "buy the dividend" or not if you are planning on holding the investment for at least a quarter? You will just have to pay taxes on the dividend distribution that occurs at the end of the next quarter, and the quarter after that, and so on.

For example:

Vanguard total stock market index distributes dividends quarterly. The next distribution will likely occur in mid-December based on past distributions:

https://personal.vanguard.com/us/funds/ ... =INT#tab=4

Let's say I buy the fund on the day before the distribution date. I take a distribution and owe taxes on it.

Now let's say I buy the fund on the day after the distribution date. I don't take the distribution and don't owe taxes on it, but then 3 months later the next distribution will be paid out. I will take that distribution and owe taxes on it. In effect you are always anywhere from 1-90 days away from "buying the dividend" no matter when you invest.

I guess this just doesn't seem like a big deal to me. If you are a buy and hold investor and buy TSM, you will end up paying taxes on dividend distributions that occur quarterly. Delaying your investing decision because of a dividend payment just seems like kicking the can down the road.

Am I missing something here?

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Re: question about "avoid buying the dividend"

Post by nordlead » Wed Oct 22, 2014 11:37 am

Basically, if you are 2-3 days before the dividend there is no point in paying more taxes (unless you like paying taxes). But if you are weeks or months away, then it makes sense to invest now.

However, as you point out, it isn't the worst thing in the world to do if you are in it for the long haul.

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Re: question about "avoid buying the dividend"

Post by ogd » Wed Oct 22, 2014 11:39 am

hudson4351 wrote:I guess this just doesn't seem like a big deal to me. If you are a buy and hold investor and buy TSM, you will end up paying taxes on dividend distributions that occur quarterly. Delaying your investing decision because of a dividend payment just seems like kicking the can down the road.
Yes, this only saves you a quarter's worth of dividend taxes. The advice only applies to purchases that are close to the dividend dates (and you could simply wait another day or two), or to investors (mistakenly) considering buying dividends on purpose. Still, one quarter is better than nothing.

You can do a bit of math to decide whether to wait N days to skip a dividend. Say we're talking about Total Stock Market with its 1.78% dividend.
Dividend taxes avoided: 15% of 1/4th of 1.78% = 0.09%
Average stock market returns in N days: N/365 * 7%. Constraining to < 0.09% means N < 5.

So hardly worth waiting more than a day or two.

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Re: question about "avoid buying the dividend"

Post by nisiprius » Wed Oct 22, 2014 11:48 am

It's not a great big deal. It's basically stale advice. The tax considerations are what they are, but the real meaning of the advice is "don't get taken by a dishonest sales technique" which... surely???? ... is not used any more. It comes from the days when unscrupulous stockbrokers would urge their naïve customers to hurry up and buy a certain stock right now, because thanks to his fabulous sources of information the broker just happened to know that this stock was due to pay a dividend, so by buying right now you could instantly score 2% return on your investment.
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Re: question about "avoid buying the dividend"

Post by bhsince87 » Wed Oct 22, 2014 11:59 am

I think it's also possible that if you haven't owned the shares at least 60 days, the dividend could be taxed as regular income, and not at the lower rate for qualified dividends.
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Re: question about "avoid buying the dividend"

Post by livesoft » Wed Oct 22, 2014 12:02 pm

Also be aware about what causes a qualified dividend to be morphed into a non-qualified dividend because the latter has a higher tax rate. One may say, "But I am going to hold the shares more than 61 days anyways." But we have seen in the past few weeks that folks are NOT going to hold the shares for 61 days because they want to sell now in order to tax-loss harvest.
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Re: question about "avoid buying the dividend"

Post by ogd » Wed Oct 22, 2014 12:38 pm

bhsince87 wrote:I think it's also possible that if you haven't owned the shares at least 60 days, the dividend could be taxed as regular income, and not at the lower rate for qualified dividends.
You can round up the 60 days after buying, I believe.

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Re: question about "avoid buying the dividend"

Post by ralph124cf » Wed Oct 22, 2014 12:58 pm

For stocks that pay regular dividends quarterly, this probably does not matter.

Many mutual funds only pay dividends once a year, and usually late in the year. If you buy in late December and the dividend is paid a few days later and credited as a reinvestment, you will have taxable income in this year, while net asset value of your total investment stays the same. You will owe tax for this year on "phantom" gains.

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hudson4351
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Re: question about "avoid buying the dividend"

Post by hudson4351 » Wed Oct 22, 2014 1:04 pm

ogd wrote:
bhsince87 wrote:I think it's also possible that if you haven't owned the shares at least 60 days, the dividend could be taxed as regular income, and not at the lower rate for qualified dividends.
You can round up the 60 days after buying, I believe.
Could you elaborate on this? What do you mean "you can round up the 60 days after buying"? I understand the statement that shares owned less than 60 days are not eligible for qualified dividends.

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Re: question about "avoid buying the dividend"

Post by abyan » Wed Oct 22, 2014 8:52 pm

They mean you can accumulate the 60 days after you buy the stock. From investopedia:
Qualified dividends are taxed at either 0% or 15% depending on the tax status of the investor. Dividends collected with a short term dividend capture strategy fail to meet the necessary holding conditions to receive the favorable tax treatment and are therefore, taxed at the investor's ordinary income tax rate. According to the IRS, in order to be qualified for the 0/15% tax rate, "you must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date."
http://www.investopedia.com/articles/st ... rategy.asp

In other words, during the period that starts 60 days before the dividend is issued, and ends 60 days after it's issued, you must hold the stock for more than 60 days. So if you buy the stock the day before the dividend issues, just make sure you hold it for 61 days. Of course, if the company is going bankrupt, you might so better selling the stock immediately and not worrying about your qualified dividend ;-)

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Re: question about "avoid buying the dividend"

Post by hudson4351 » Wed Oct 22, 2014 9:25 pm

abyan wrote:They mean you can accumulate the 60 days after you buy the stock. From investopedia:
Qualified dividends are taxed at either 0% or 15% depending on the tax status of the investor. Dividends collected with a short term dividend capture strategy fail to meet the necessary holding conditions to receive the favorable tax treatment and are therefore, taxed at the investor's ordinary income tax rate. According to the IRS, in order to be qualified for the 0/15% tax rate, "you must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date."
http://www.investopedia.com/articles/st ... rategy.asp

In other words, during the period that starts 60 days before the dividend is issued, and ends 60 days after it's issued, you must hold the stock for more than 60 days. So if you buy the stock the day before the dividend issues, just make sure you hold it for 61 days. Of course, if the company is going bankrupt, you might so better selling the stock immediately and not worrying about your qualified dividend ;-)
Thanks, that makes sense.

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Re: question about "avoid buying the dividend"

Post by grabiner » Wed Oct 22, 2014 9:51 pm

ralph124cf wrote:For stocks that pay regular dividends quarterly, this probably does not matter.

Many mutual funds only pay dividends once a year, and usually late in the year. If you buy in late December and the dividend is paid a few days later and credited as a reinvestment, you will have taxable income in this year, while net asset value of your total investment stays the same. You will owe tax for this year on "phantom" gains.
This is even more of an issue if the fund is going to distribute a capital gain, because these may be much larger than the dividends and are distributed only once a year. It made sense for me to wait a full month to buy VSS (Vanguard FTSE All-World Ex-US Small-Cap ETF) in my taxable account in 2010, because the annual dividend was partly non-qualified and there was a capital gain as well.
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Re: question about "avoid buying the dividend"

Post by hudson4351 » Tue Nov 04, 2014 11:24 pm

grabiner wrote:
ralph124cf wrote:For stocks that pay regular dividends quarterly, this probably does not matter.

Many mutual funds only pay dividends once a year, and usually late in the year. If you buy in late December and the dividend is paid a few days later and credited as a reinvestment, you will have taxable income in this year, while net asset value of your total investment stays the same. You will owe tax for this year on "phantom" gains.
This is even more of an issue if the fund is going to distribute a capital gain, because these may be much larger than the dividends and are distributed only once a year. It made sense for me to wait a full month to buy VSS (Vanguard FTSE All-World Ex-US Small-Cap ETF) in my taxable account in 2010, because the annual dividend was partly non-qualified and there was a capital gain as well.
The funds I am planning to invest in are:


Vanguard Total International Stock Index Fund Admiral Shares (VTIAX) (https://personal.vanguard.com/us/funds/ ... =INT#tab=4)
Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX) (https://personal.vanguard.com/us/funds/ ... =INT#tab=4)
Vanguard Intermediate-Term Tax-Exempt Fund Admiral Shares (VWIUX) (https://personal.vanguard.com/us/funds/ ... =INT#tab=4)

Based on the "Distributions" tabs I have provided links for, it looks like TSM and TISM distribute dividends quarterly, at least for the period shown. I don't see any "capital gains" listed. Should there be? Do these funds normally have a yearly capital gain distribution? I know the turnover is low, but shouldn't it be greater than 0, which would create a capital gain?

The tax exempt fund seems to have monthly dividends and no capital gains. Should there be capital gains for this fund? I guess it doesn't matter since it's tax exempt.

Also when you say "the annual dividend was partly non-qualified", how can you tell? Where does it say what percent of the dividend is qualified?
Last edited by hudson4351 on Tue Nov 04, 2014 11:43 pm, edited 1 time in total.

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Re: question about "avoid buying the dividend"

Post by hudson4351 » Tue Nov 04, 2014 11:40 pm

ogd wrote:
hudson4351 wrote:I guess this just doesn't seem like a big deal to me. If you are a buy and hold investor and buy TSM, you will end up paying taxes on dividend distributions that occur quarterly. Delaying your investing decision because of a dividend payment just seems like kicking the can down the road.
Yes, this only saves you a quarter's worth of dividend taxes. The advice only applies to purchases that are close to the dividend dates (and you could simply wait another day or two), or to investors (mistakenly) considering buying dividends on purpose. Still, one quarter is better than nothing.

You can do a bit of math to decide whether to wait N days to skip a dividend. Say we're talking about Total Stock Market with its 1.78% dividend.
Dividend taxes avoided: 15% of 1/4th of 1.78% = 0.09%
Average stock market returns in N days: N/365 * 7%. Constraining to < 0.09% means N < 5.

So hardly worth waiting more than a day or two.
Just out of curiosity, is your dividend of 1.78% just the listed "SEC Yield" on the TSM page on the day you made this post?

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Re: question about "avoid buying the dividend"

Post by grabiner » Wed Nov 05, 2014 12:35 am

hudson4351 wrote:
grabiner wrote:
ralph124cf wrote:For stocks that pay regular dividends quarterly, this probably does not matter.

Many mutual funds only pay dividends once a year, and usually late in the year. If you buy in late December and the dividend is paid a few days later and credited as a reinvestment, you will have taxable income in this year, while net asset value of your total investment stays the same. You will owe tax for this year on "phantom" gains.
This is even more of an issue if the fund is going to distribute a capital gain, because these may be much larger than the dividends and are distributed only once a year. It made sense for me to wait a full month to buy VSS (Vanguard FTSE All-World Ex-US Small-Cap ETF) in my taxable account in 2010, because the annual dividend was partly non-qualified and there was a capital gain as well.
The funds I am planning to invest in are:


Vanguard Total International Stock Index Fund Admiral Shares (VTIAX) (https://personal.vanguard.com/us/funds/ ... =INT#tab=4)
Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX) (https://personal.vanguard.com/us/funds/ ... =INT#tab=4)
Vanguard Intermediate-Term Tax-Exempt Fund Admiral Shares (VWIUX) (https://personal.vanguard.com/us/funds/ ... =INT#tab=4)

Based on the "Distributions" tabs I have provided links for, it looks like TSM and TISM distribute dividends quarterly, at least for the period shown. I don't see any "capital gains" listed. Should there be? Do these funds normally have a yearly capital gain distribution? I know the turnover is low, but shouldn't it be greater than 0, which would create a capital gain?
Stock index funds with ETFs are unlikely to distribute capital gains, because of the ETF structure. With quarterly dividends, the dividend will be very low and taxed at a low rate (Total Stock Market's dividend will be close to 100% qualified, and Total International's dividend will probably be 2/3 qualified and eligible for the foreign tax credit). Therefore, you shouldn't worry about "buying a dividend" on either of those funds. If you put $10,000 in Total Stock Market, and it pays a normal 0.5% dividend taxed at 15% federal plus 5% state, the tax will be $10; you expect to lose more than $10 by staying out of the stock market for a week. (In the example for which I waited a month, I expected a tax cost of about $80 on a $10,000 investment.)

Bond funds pay a dividend for every day you own the fund, so "buying a dividend" is irrelevant; if you buy on November 30, you will only get 1/30 of the November dividend. In any case, the dividend from Intermediate-Term Tax-Exempt is free of federal tax, although it might be taxed by your state.
Also when you say "the annual dividend was partly non-qualified", how can you tell? Where does it say what percent of the dividend is qualified?
Look in the Vanguard Tax Center for qualified dividend information for all Vanguard funds.
Just out of curiosity, is your dividend of 1.78% just the listed "SEC Yield" on the TSM page on the day you made this post?
This is correct for a US stock fund. Vanguard doesn't publish yields for its international funds, so you have to look at historical distributions to estimate the dividend yield.

For bond funds, the SEC yield may not be equal to the dividend, as the SEC yield takes into account the change in bond price if a bond is held to maturity. (For example, if you bought a bond worth $10,000 which pays $440 in annual dividends, and the bond is worth $11,000 five years before maturity, you will receive 4% of the bond's value as a dividend, but the SEC yield will be about 2% because the bond will decline in value by $200 per year and thus your annual return for holding to maturity is only about 2%.)
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Re: question about "avoid buying the dividend"

Post by hudson4351 » Wed Nov 05, 2014 10:24 am

Thanks for the info grabiner.

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Re: question about "avoid buying the dividend"

Post by House Blend » Wed Nov 05, 2014 2:22 pm

nisiprius wrote:It's not a great big deal. It's basically stale advice. The tax considerations are what they are, but the real meaning of the advice is "don't get taken by a dishonest sales technique" which... surely???? ... is not used any more.
Yes, it is amazing how many new Bogleheads starting a taxable account at Vanguard get misled into worrying about this.

But to be fair, I don't think it is (completely) stale advice.

It is easy to forget that there is a wild world out there outside of Vanguard funds. In that world, large end of year distributions (cap gains plus dividends) are still common.

I own a small cap index fund in my 403b. Not a Vanguard fund.

Last year, it distributed about 4.4% in dividends and capital gains on Dec. 12. I would have been very annoyed if I were holding that fund in taxable, and even more annoyed if I had bought taxable shares in the previous week or so. (Although I should put my hindsight glasses on and look to see if market movements in the days leading up to that were enough to overcome the extra taxes.)

The actively managed small cap fund available in my plan (not something I own) distributed about 9% on the same day.

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Re: question about "avoid buying the dividend"

Post by grabiner » Wed Nov 05, 2014 9:36 pm

House Blend wrote:But to be fair, I don't think it is (completely) stale advice.

It is easy to forget that there is a wild world out there outside of Vanguard funds. In that world, large end of year distributions (cap gains plus dividends) are still common.
And even within Vanguard, you should check for the occasional exception, such as my example in this thread. Many ETFs distribute capital gains when they get started; the creation/redemption process is more effective at reducing gains when shares have been bought at a wide range of prices. In particular, Vanguard FTSE All-World Ex-US Small-Cap started near the 2009 market bottom, so when it sold shares in 2009 and 2010 as the index changed, it didn't have many shares with losses to sell. and distributed capital gain. Therefore, before buying a new ETF late in the year, check the planned distribution.
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Re: question about "avoid buying the dividend"

Post by hudson4351 » Thu Dec 17, 2015 12:04 pm

abyan wrote:They mean you can accumulate the 60 days after you buy the stock. From investopedia:
Qualified dividends are taxed at either 0% or 15% depending on the tax status of the investor. Dividends collected with a short term dividend capture strategy fail to meet the necessary holding conditions to receive the favorable tax treatment and are therefore, taxed at the investor's ordinary income tax rate. According to the IRS, in order to be qualified for the 0/15% tax rate, "you must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date."
http://www.investopedia.com/articles/st ... rategy.asp

In other words, during the period that starts 60 days before the dividend is issued, and ends 60 days after it's issued, you must hold the stock for more than 60 days. So if you buy the stock the day before the dividend issues, just make sure you hold it for 61 days. Of course, if the company is going bankrupt, you might so better selling the stock immediately and not worrying about your qualified dividend ;-)
I was rereading your post and am now confused. Dividends are reported on a 1099-DIV form at the end of each year or early in the following year for the prior tax year. The amount of qualified dividends are identified on this form. You have to hold shares for 61 days for their dividends to be considered qualified, but that 61-day period begins 60 days before the dividend date and ends 60 days after it is issued.

Let's say I buy shares in a mutual fund right before it's final quarterly dividend distribution in December. That leaves me with ~2 weeks remaining in the tax year, or 14 days. A 1099-DIV form for that tax year will only be "aware" of the 14 days in that year that I held those shares. Will those dividends be reported as qualified or non-qualified?

Let's say I then hold those shares for an additional 47 days going into the new year. That would meet the 61 day holding requirement, but the 1099-DIV form would have already been issued for the dividends paid the previous December. How is this resolved? Do I need to file an amended return or will the correction be automatically incorporated into the next 1099-DIV form?

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Re: question about "avoid buying the dividend"

Post by hudson4351 » Thu Dec 17, 2015 12:10 pm

ralph124cf wrote:For stocks that pay regular dividends quarterly, this probably does not matter.

Many mutual funds only pay dividends once a year, and usually late in the year. If you buy in late December and the dividend is paid a few days later and credited as a reinvestment, you will have taxable income in this year, while net asset value of your total investment stays the same. You will owe tax for this year on "phantom" gains.

Ralph
How is this any different from the case where you bought the fund on January 1st of that year? In either case the dividend/capital gain is paid out and credited as a reinvestment and counted as taxable income, while the NAV of your investment will stay the same.

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Re: question about "avoid buying the dividend"

Post by RetireGood » Thu Dec 17, 2015 12:59 pm

abyan wrote: Let's say I buy shares in a mutual fund right before it's final quarterly dividend distribution in December. That leaves me with ~2 weeks remaining in the tax year, or 14 days. A 1099-DIV form for that tax year will only be "aware" of the 14 days in that year that I held those shares. Will those dividends be reported as qualified or non-qualified?

Let's say I then hold those shares for an additional 47 days going into the new year. That would meet the 61 day holding requirement, but the 1099-DIV form would have already been issued for the dividends paid the previous December. How is this resolved? Do I need to file an amended return or will the correction be automatically incorporated into the next 1099-DIV form?
I think The 1099-DIV are sent late but before APR 15 . So most of the time, you get correct 1099-DIV

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Re: question about "avoid buying the dividend"

Post by grabiner » Thu Dec 17, 2015 9:42 pm

hudson4351 wrote:I was rereading your post and am now confused. Dividends are reported on a 1099-DIV form at the end of each year or early in the following year for the prior tax year. The amount of qualified dividends are identified on this form. You have to hold shares for 61 days for their dividends to be considered qualified, but that 61-day period begins 60 days before the dividend date and ends 60 days after it is issued.

Let's say I buy shares in a mutual fund right before it's final quarterly dividend distribution in December. That leaves me with ~2 weeks remaining in the tax year, or 14 days. A 1099-DIV form for that tax year will only be "aware" of the 14 days in that year that I held those shares. Will those dividends be reported as qualified or non-qualified?
The 1099-DIV will report the dividend as qualified, because the brokerage is not aware of anything that has made it non-qualified. It's your responsibility to correct this, just as it is your responsibility to report such things as wash sales which your brokerage doesn't know about. (The IRS has no reason to complain if your tax return disagrees with the 1099s it received, as long as the discrepancies can only lead to a higher tax bill.)
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Re: question about "avoid buying the dividend"

Post by hudson4351 » Mon Dec 21, 2015 11:49 am

hudson4351 wrote:
ralph124cf wrote:For stocks that pay regular dividends quarterly, this probably does not matter.

Many mutual funds only pay dividends once a year, and usually late in the year. If you buy in late December and the dividend is paid a few days later and credited as a reinvestment, you will have taxable income in this year, while net asset value of your total investment stays the same. You will owe tax for this year on "phantom" gains.

Ralph
How is this any different from the case where you bought the fund on January 1st of that year? In either case the dividend/capital gain is paid out and credited as a reinvestment and counted as taxable income, while the NAV of your investment will stay the same.
Does anyone know the answer to this?

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Re: question about "avoid buying the dividend"

Post by alex_686 » Mon Dec 21, 2015 12:01 pm

hudson4351 wrote:
hudson4351 wrote:
ralph124cf wrote:For stocks that pay regular dividends quarterly, this probably does not matter.

Many mutual funds only pay dividends once a year, and usually late in the year. If you buy in late December and the dividend is paid a few days later and credited as a reinvestment, you will have taxable income in this year, while net asset value of your total investment stays the same. You will owe tax for this year on "phantom" gains.

Ralph
How is this any different from the case where you bought the fund on January 1st of that year? In either case the dividend/capital gain is paid out and credited as a reinvestment and counted as taxable income, while the NAV of your investment will stay the same.
Does anyone know the answer to this?
The tax drag is higher. Let us say you have a $10 mutual fund that pays a $1 dividend.

If you buy the mutual fund the day before the capital gains dividend you would immediate accrue a tax liability. For this example let us call it $.33. The hit in performance would be similar to buying a fund with a front end load.

If you buy the mutual fund the day after the capital gains, you would still need to pay the $.33 - however it would be in the following year. So you delay a payment to the tax man, and the $.33 works for you for an entire year.

Time value of money.

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Re: question about "avoid buying the dividend"

Post by hudson4351 » Mon Dec 21, 2015 1:14 pm

alex_686 wrote:
hudson4351 wrote:
hudson4351 wrote:
ralph124cf wrote:For stocks that pay regular dividends quarterly, this probably does not matter.

Many mutual funds only pay dividends once a year, and usually late in the year. If you buy in late December and the dividend is paid a few days later and credited as a reinvestment, you will have taxable income in this year, while net asset value of your total investment stays the same. You will owe tax for this year on "phantom" gains.

Ralph
How is this any different from the case where you bought the fund on January 1st of that year? In either case the dividend/capital gain is paid out and credited as a reinvestment and counted as taxable income, while the NAV of your investment will stay the same.
Does anyone know the answer to this?
The tax drag is higher. Let us say you have a $10 mutual fund that pays a $1 dividend.

If you buy the mutual fund the day before the capital gains dividend you would immediate accrue a tax liability. For this example let us call it $.33. The hit in performance would be similar to buying a fund with a front end load.

If you buy the mutual fund the day after the capital gains, you would still need to pay the $.33 - however it would be in the following year. So you delay a payment to the tax man, and the $.33 works for you for an entire year.

Time value of money.
OK, that make sense, although as ogd pointed out above you are potentially missing out on stock market gains by delaying your purchase, which could offset any taxes you save by waiting until after the dividend/capital gain is paid. This would be a bigger issue with mutual funds that pay a single large capital gain annually as opposed to quarterly qualified dividends.

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