Taxes and the Ex-dividend Date
Question: When selling a stock or bond mutual fund, is it better to: Wait a few days to the Ex-Dividend date, receive the dividend and sell at the lower Ex-Div price? Or Sell before the Ex-Div date, receive the higher pre-Ex-Div price and forego the dividend? Very thankful for your program and your advice. Phil
Answer: The ex-dividend date means that owners of record are eligible for all dividends and capital gains distributions. Even if you sell your shares on or after the ex-divident date you'll receive the distributions. The distribution of mutual fund dividends and capital gains has an impact on the share price of a mutual fund. On the ex-dividend date the share price drops by the amount of the distribution (that is, plus or minus change in the market). So, if the share price is $10 and the distribution is $1.00, the mutual fund's net asset value (NAV) should drop to $9.00 (the price will depart from that value depending on what happens in the market that day).
The main implication to keep in mind when buying and selling mutual fund shares around the ex-dividend date is taxes.
On selling: The key question is to look at the tax bill from the distribution (where the federal rate can climb as high as 35%) versus long-term capital gains if you've owned the mutual fund shares longer than a year (where the tax bill is 15% or less). It often pays to sell before the distribution if you qualify for the 15% federal capital gains tax rate--but not always. The hated phrase is "it all depends" is right it this case. It all depends on comparing the actual tax bills and see where you come out ahead.
On buying: The Wall Street jargon is that you don't want to "buy the tax liability." For instance, lets say you purchase some mutual fund shares just a few days before it goes ex-dividend. The new investor will then watch the value of their shares fall by the amount of the distribution and owe taxes on the distribution. Ouch.
Here's an example on buying courtesy of mutual fund giant Vanguard
Say you invest $5,000 on December 15 (record date), buying 250 shares for $20 each. If the fund pays a distribution of $1 per share on December 16, its share price will drop to $19 (not counting market change). You still have $5,000 in value (250 shares x $19 = $4,750 in share value, plus 250 shares x $1 = $250 in distributions), but you owe tax on the $250 distribution you received--even if you reinvest it in more shares.
In other words, the long-term investor enjoys the payoff from dividends and capital gains (and pays taxes on the gain). The short-term investor mostly gets to write a check to Uncle Sam.