During the month of December mutual funds often make large cash distributions to shareholders based on the capital gains that were recognized during the year. These distributions can cause some large fluctuations in the daily price of the fund and can unnerve investors who simply look at the ‘daily change’ on the Schwab website. So, what are Capital Gain Distributions and why do they cause such significant swings in the price of the Mutual Fund?
During the year mutual funds buy and sell individual stocks, which creates gains for the investors. For example, if the fund purchases 10 shares of Apple stock for $1,500 and later sells Apple stock for $1,800, the fund has generated a $300 ‘Capital Gain’ ($1,800 - $1,500). Since funds will buy and sell throughout the year these gains accumulate all year long. However, the tax code requires that the majority of capital gains be distributed, so funds will analyze the gains in the fund in December and send the gain to shareholders in cash.
When cash is distributed by the fund it reduces the price (net asset value) of the fund. For example, if the fund is worth $100 and has a 5% capital gain distribution, it will send $5 cash to the shareholders and the price of the fund will decline to $95. On the Schwab website, the fund will show a 5% decline for the day and the cash will arrive one or two days later. These large swings in the daily value can be unnerving to those who track the daily change in their account. Rest assured however that the investment is made whole by the cash received.
Ultimately, capital gains are a wonderful thing – they are an important part of your investment return. We will often use the cash generated by capital gain distributions to rebalance our accounts and make investments in key areas. If you have any questions about what is happening in your account, please feel free to reach out. We would be happy to walk through any changes in your account.