Timing is important when buying into a mutual fund
By Dave Claus dave@wagnerfinancial.com

Here's a great question a student recently asked me at one of my classes on investing and retirement planning at Ventura College:

I'm thinking about buying a new mutual fund, but I've heard that capital gains taxes can hurt me. What should I do?

This is an important question for almost everyone building their savings, since mutual funds are one of the most common types of investments. Most retirement accounts like 401(k)s and IRAs are full of mutual funds with managers that shop for the best combination of stocks, bonds or other investments to keep their investors happy.

When preparing to buy, sell or trade a mutual fund, it's vital to do your homework. If you buy at the end of the year-but before capital gains are distributed-you could end up paying for gains you never enjoyed. Investors who buy with mutual fund gains distributions in mind can end up with better bargains (but more on that later.)

Instead, be sure to check a mutual fund company's website to find out exactly when its gains for the year will be distributed. If practical, buy the fund right after the distribution date. That way, you may get to enjoy every bit of the gains Uncle Sam makes investors pay for every year in taxes.

Here is an example of what not to do when shopping for a mutual fund. Suppose an investor spots an attractive mutual fund in late October that he believes is going to deliver a good return.

He makes the investment right away, hoping for the best. In December he enters the fund's ticker symbol on his favorite finance website and sees its price graph line headed south. He begins to panic. Did he make a poor investment?

A few months later, he gets a 1099 in the mail indicating he must pay the IRS for gains. "What gains?" he wonders. From the price graph he read, the fund didn't appear to make a gain.

The above example is usually a case of investor confusion, not of a poor-performing mutual fund. Buy a mutual fund just before its gains are distributed back to investors and you may suffer from most of the gains taxes and little of the actual annual gain in value.

By law, fund companies must distribute 90 percent of realized capital gains and dividends each year. Mutual funds usually make their distributions in November or December (usually late December). Buying just before this happens can result in all of the tax pain with few realized gains.

Adding to the confusion are financial graphs that don't deliver a complete performance picture. Some show mutual funds taking a sharp dip around December. Does this indicate negative performance? Not necessarily.

December chart dips often simply indicate that gains distributed to investors have been re-invested. This increases the shares outstanding and dilutes the price per share. The fund's price, or NAV, drops by the exact amount of the distribution. Similar to the effect of a stock split, this is a good thing for investors who bought at a good price.

Savvy investors who take the time to learn the right time to buy mutual funds can turn common confusion into a competitive edge.

Suppose a wellinformed investor finds a mutual fund that posted losses over several years. She's interested because the fund just hired a new manager with a great track record who should turn around performance. She realizes that all those years of losses can absorb future gains for many of the stocks in the

fund. This gives her the opportunity to enjoy future capital gains in the fund without the usual taxes.

Bear in mind that capital gains distributions are typically not an issue for retirement accounts.

Securities and investment advice offered through Transamerica Financial Advisors, Inc., 1001 Partridge Drive, Ste. 110, Ventura, (805) 339-0760 .