Dear Dr. Don,
Mutual funds all receive interest and/or dividend income from the bonds and stocks they hold. I wonder when and how these incomes are added to the net asset value, or NAV, of a fund unit. If the addition is made only once or twice a year, when the funds get payments from the bonds/stocks, would it mean that some people can make a quick buck by buying before and selling after the addition?
— Henry Hijinks
You got me to look. The addition isn’t made once or twice a year, it’s made daily. The daily net income of the mutual fund is included in calculating the mutual funds net asset value.
Every day, the mutual fund calculates its net asset value based on the value of its holdings, less any liabilities, divided by the number of shares outstanding.
Mutual funds, by law, have to distribute this income, along with any realized capital gains, out to investors. This law keeps the mutual fund from having to pay taxes on the investment earnings. They’re passed through to the investor, who then pays the taxes.
Buying a mutual fund just before a distribution date means that the new investor will pay the taxes on the distribution. This can result in an unexpected, and unwelcome, tax bill. It’s always a good idea to check the distribution calendar before buying a mutual fund in a taxable account. The fund’s NAV will drop by the value of the distribution.
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