Capital gains distribution

Capital gains distribution

A distribution to the shareholders of a mutual fund out of profits from selling stocks or bonds, that is subject to capital gains taxes for the shareholders.

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capital gains distribution

Payments to investment company shareholders based on gains from securities in the firm's portfolio that have been sold. These gains are passed through to the shareholders and are taxed to the shareholders. Distributions usually occur once each year.

Case Study Capital gains distributions can produce unexpected tax problems for mutual fund shareholders, especially investors who acquire mutual fund shares following a major increase in stock values. An even greater surprise occurs when a large distribution occurs during a year of poor market performance. Mutual funds are required to distribute to their shareholders all of the net gains the funds realize through the sale of securities. Unfortunately for some investors, gains that occur during one period are realized and distributed in a subsequent period. Buy a mutual fund following a major increase in stock values and you are likely to receive distributions on gains from which you did not benefit. In 2000 Warburg Pincus Asset Management made a capital gains distribution equal to a stunning 55% of assets to the shareholders of its Warburg Pincus Japan Small Company Fund. The distribution was occasioned by a year of spectacular gains in 1999 (a return of 329%) followed by a year of poor performance with resulting shareholder redemptions that forced portfolio managers to sell stocks to raise cash. Stock sales by the fund produced capital gains that triggered the distribution by Warburg Pincus. Although mutual funds typically make distributions during the end of the calendar year, Warburg Pincus officials indicated their distribution was made early in the year to allow shareholders time to take care of any tax liability. In a similar event, in December 2000 Select Software and Computer Services Fund distributed nearly 40% of its net asset value even though the fund was down over 9% for the year. Investors who purchased shares in the fund in early 2000 received a large taxable distribution even though their shares had lost market value during the year. Woe to the investor who fails to research a mutual fund purchase.

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Capital gains distribution. When mutual fund companies sell investments that have increased in value, the profits, or capital gains, are passed on to their shareholders as capital gains distributions.

These distributions are made on a regular schedule, often at the end of the year and are taxable at your regular rate unless the funds are held in a tax-deferred or tax-free account.

Most funds offer the option of automatically reinvesting all or part of your capital gains distributions to buy more shares.