by B. Iris Tanner

Created on: May 28, 2008   Last Updated: September 02, 2008

Timing your purchase of a stock in order to receive a dividend is often considered a smart move. However, trying to time a mutual fund investment in order to "capitalize" on a dividend is anything BUT smart, and can really work against you at tax time. That makes the title of this article a real misnomer and I hope you will read it carefully to understand why it should not influence your investment decisions!

Consider your overall gain or loss on any type of investment. You may benefit from dividends or interest payments along the way, but your original purchase price will ultimately have a much greater impact on your performance results. If you buy when the price is relatively low, and sell when it is higher, you are going to come out ahead. If you buy at a high price and the price goes down, you will have a loss if you sell. You certainly wouldn't deliberately buy an investment that you knew was going to go down in price - or would you? Because buying into a fund to receive its annual dividend is doing exactly that!

Mutual fund share prices are calculated daily and reflect the value of the fund's assets after all its liabilities are accounted for. So, if some of those assets have appreciated or earned income for the fund, the share price will increase to reflect this. However, once the fund declares a dividend, it incurs a liability. When that dividend is paid out, the share price will fall by the amount of the dividend. If you bought mutual fund shares just before the dividend payout, you will get a check in the mail, all right - but since your fund investment will decline by the same amount, you haven't actually gained anything. Furthermore, because of the tax rules that apply to mutual fund distributions, you will have to pay tax on the dividend you received, even though it is essentially a refund of your own money!

Many people think they can get around this situation by reinvesting their dividends into additional fund shares. In this case, you don't receive a check in the mail, just a statement that tells you how many shares (or partial shares) your dividend purchased. However, whether or not you actually receive a check, the IRS still requires you to pay taxes on the dividend. (Fortunately, the mutual fund companies will calculate this amount and report it to you so you don't have to worry about the math.)

So, if you are planning to invest in a mutual fund toward the end of a calendar year, you can minimize any tax bite by using a systematic payment plan. Instead of investing a large lump sum, you arrange to pay a certain amount each month. This is actually a smart way to buy mutual funds because of the fluctuations in their share prices - your investment dollar will buy more shares when the price is low, and over time you will probably do better in terms of performance than you would with a single lump-sum investment.

If you do want to invest a larger sum (lucky you!)it's advisable to contact the fund company first and inquire if the fund will be paying a distribution for the year. If so, find out when this will happen. Then, make your purchase after the ex-dividend date. You'll start out with a lower initial price, get more shares for your money, and not have to worry about paying taxes on something that doesn't actually constitute a gain!

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