Watch Out—Capital Gains Distribution Season Is Back

Distribution Season Is Back—With Some Nasty Surprises in Store

November 9, 2022

The markets have been anything but nice this year, but it’s mutual fund investors who might end up with a lump of coal in their stockings come December: Year-end fund distributions are set to begin in a few weeks, and many funds have realized capital gains despite the ongoing bear markets in both stocks and bonds.

At least once a year, mutual funds must pay out the interest and dividends they’ve received plus any capital gains they have realized to shareholders. If a stock pays a dividend, the mutual fund passes that dividend on. If a bond pays interest, that interest gets passed along as well. Blue-chip “value” stocks have been relatively strong performers this year—and that means plenty of dividends will be passed along to investors.

That any fund should have substantial capital gains in 2022 may be a little harder to understand. There are a few ways it can happen. Every fund engages in at least a little trading activity over the course of the year: Managers of active funds sell some positions and buy into others. And even passive funds may have to sell or buy stock if the composition of their underlying benchmark changes.

But the biggest factor driving realized capital gains in a down market is generally outflows: When shareholders withdraw money from a fund, the managers may need to sell stock to raise cash. The more withdrawals they face, the more they’ll need to sell to meet redemptions.

If the stock a manager sells is worth more now than it was when they bought it, they will realize a profit on the sale. And if, at the end of the year, the profits outweigh the losses from all of those sales, then the net realized “capital gains” must be distributed to shareholders.

The 10-year bull run the stock market experienced in the 2010s produced a lot of capital gains for mutual fund investors. And while the pandemic induced a sharp drop in fund values in 2020, that drop was brief and followed by an even stronger rally. It’s only now in 2022 that many formerly strong performers are facing substantial outflows.

The table below lists Vanguard funds with a realized gain of 5% or more of their share price on the books as of the close of the third quarter. These funds’ shareholders will likely face hefty tax bills once distributions are made.

Pain in Store

wdt_ID Fund Name Realized Gains as % of NAV YTD Return Unrealized Gains as of 12/31/2021 Net Flows
1 Windsor 14% -14.7% 27% -$939
2 Diversified Equity 12% -27.2% 38% -$127
3 Selected Value 11% -20.3% 25% -$340
4 Strategic Equity 10% -20.8% 25% -$293
5 PRIMECAP 8% -22.8% 65% -$3,313
6 Capital Opportunity 8% -24.3% 64% -$335
7 Growth & Income 7% -22.7% 38% -$883
8 PRIMECAP Core 7% -21.2% 59% -$279
9 STAR 7% -23.3% 38% -$1,512
10 Strategic Small-Cap Equity 6% -22.0% 18% -$98

Sources: Vanguard, Adviser.

Even if you don’t own one of the funds on the list above, it’s still a smart move to review your holdings’ upcoming estimated distributions. If held outside of tax-advantaged retirement accounts such as IRAs or 401(k)s, distributions are taxable in the year they are received and must be included in your returns next April. Knowing when and what your funds will be paying out can help you avoid costly surprises.

This can be a little tricky. There are two key dates you’ll need to know: Your fund’s “record date” and its “ex-dividend” date.

The record date is the deadline by which investors must be on the company’s books in order to receive a fund’s payout. If you own shares by the fund’s record date, you are eligible for distributions.

The ex-dividend date is the date on which the fund’s price is reduced by the amount of the dividend or capital gain. The ex-dividend date is usually one business day after the record date. If you purchase shares of a fund prior to its ex-dividend date, you’ll pay taxes on the distributions even if you didn’t own the shares when that income was earned.

In other words, you should avoid buying into a fund shortly before the ex-dividend date—otherwise you could end up “buying the distribution” and paying taxes on gains you never actually realized. Instead of buying now, we advise that investors wait until after the ex-dividend date to buy a fund (or additional shares) for taxable accounts.

Fidelity fund investors can find a searchable list of funds’ distribution dates and estimated capital gains here. Vanguard investors can find a list of funds’ distribution dates here; the firm will release official capital gains estimates on Nov. 14.

All ex-dividend and payable dates are subject to change. You should check the date on the fund’s official informational materials before deciding to buy or sell shares of a particular fund.  

Chart of the Week: Are Commodities an Inflation Refuge?

Director of Research Jeff DeMaso By Director of Research Jeff DeMaso

With inflation still running around 8% year-over-year, protecting portfolios against rising prices is top of mind. Unfortunately, many so-called inflation hedges have let investors down. Notably, both gold (-10%) and bitcoin (-55%)—also known as “digital gold”—have failed to live up to their overstated reputations this year.

But how about the broader basket of commodities, which includes precious and industrial metals, livestock, oil, natural gas, coffee, cotton, sugar, grains, soybeans, etc.?

Commodities initially provided some solid inflation protection for investors this year. Prices (measured by the Bloomberg Commodity Index) gained 22% in the first half of 2022. And they about doubled from their initial pandemic lows (April 2020).

That all sounds pretty good… However, since their June high, commodity prices are down about 17% even as reported inflation remains elevated.

A chart showing the change in value of the Bloomberg Commodity Index from December 2019 through October 2022.
Note: Chart shows weekly index level for the Bloomberg Commodity Index from December 2019 through October 2022. Source: Bloomberg.

Viewed through a longer lens, commodities have simply not been a good hedge against inflation over time.

In 1991, the Bloomberg Commodity Index was trading around 100. It’s been a wild ride since then, but the index is still, 30-some years later, trading around 100, meaning that overall prices have gone nowhere.

Commodities tend to be uncorrelated to stocks or bonds. This means they move to their own beat and can provide periods of opportunity for investors if you can time it right—but their long-term returns leave a lot to be desired.

No Long-Term Inflation Protection from Commodities
Note: Chart shows monthly index level for the Bloomberg Commodity Index from January 1991 through October 2022 as well as monthly changes to the inflation rate (using a starting value of 100 and returns of the IA SBBI U.S. Inflation index) over the same period. Sources: Bloomberg, Morningstar.

Adviser’s Takeaways

In recent Takeaways, Wealth Adviser Diana Linn discussed whether I-Bonds are still worth your time, while Senior Research Analyst Liz Laprade discussed the midterm election’s impact. We hope you find these episodes engaging and accessible. If there are any topics you’d like us to address, please send an email to info@adviserinvestments.com!

About Adviser Investments

Adviser is a full-service wealth management firm, offering investment managementfinancial and tax planningmanaged individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994. Adviser Investments and its subsidiaries have over 5,000 clients across the country and over $8 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.


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