Blogs & Comment

Beware of year-end capital distributions

The year end is not a good time to buy mutual funds, especially actively managed funds with high turnover in portfolios. They often distribute capital gains that are taxable to unitholders (if the funds are being held outside registered accounts).
These taxes have to be paid by unitholders on record, So,if they buyjust before the date of record (near the end of the year), they will be paying tax on gains they never participated in.
Heres an example of it works. Say you bought 100 units of Mutual Fund XYZ on Dec. 21 at a price of $55.25. Thus the total invested was $5,525.
On Dec. 23, the fund distributes $1.00 a unit, which shows up as $100 cash (or equivalentunits) in your account. The net asset value of your units will also fall by exactly that amount, to $54.25. Your total investment is still worth $5,525 only now it is in the form of $5,425 in fund units and $100 in cash (which is taxable as your T3 will report).
So its better for taxable accounts to wait until after the record date to buy mutual funds and avoid the tax. Many persons thinking of switching out of high MER muutal funds into exchange-traded funds (ETFs) have an extra incentive to do it before the year end in order toavoid the risk of capital distributions.
ETF dont distribute capital gains very often but it sometimes does happen (less so to the broadly diversified ones). The ETF unit price will be similarly adjusted down.