Let me start first by saying that my intent today is not to add to the confusion of the past few months, but facts are facts. The stock market has been on a “roller-coaster” ride, and people are reacting to it. Many investors are seeking cover because of the damage done to their portfolios, and others sense buying opportunities due to the historic lows in the market.

Whichever boat you may be in, now is the time to carefully consider ANY financial move you might be thinking about. Bearing that in mind, let’s talk about capital gains derived from mutual funds. They get paid out annually, generally in December. For those of you who have suffered losses in your mutual fund portfolio, you may have an income tax hit looming as well.

Huh? What? How is that possible? My portfolio has suffered huge losses in asset value, and now I capital gains tax to look forward to? What gives?

Well, a mutual fund (by law), has to distribute its income to its shareholders. The funds don’t get taxed, you do.

A mutual fund derives income from its various holdings stocks, bonds, etc. and pays that income out to its shareholders. This generally occurs twice a year and is known as income distribution.

Capital gains are accumulated throughout the year and are generally paid out in December.

Many investors assume that they couldn’t possibly incur any capital gains because their funds have lost too much money. Unfortunately, that isn’t the reality of the situation. A decline in a mutual fund’s share price has more to do with losses in the value of its assets, not from losses in its portfolio due to stock transactions.

One of the reasons that a person buys a mutual fund is portfolio diversity, and another is to have a money manager running their portfolio. Most managers don’t operate like the general public, i.e. buying high and selling low. A lot of managers are holding assets in anticipation of a comeback, or even buying to take advantage of value. So, the end of the year comes along, and it’s time to distribute all of those capital gains that have been accumulating inside of the fund.

What does this mean to you? This might be a good time to consider dumping some of those funds that are not performing so well. If it suits your situation, you could sell now and avoid any potential tax hit. If you are considering buying a fund, you might want to wait until after the distribution date.

Before you anything, get a hold of the fund in question and ask them if they are going to have a taxable capital gains pay out. That should help you make a decision that’s right for you, and when in doubt, consult with a trusted advisor.

For more reading on the subject, consult the following article:

http://www.filife.com/stories/fund-investors-face-risk-of-tax-hit