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How does mutual fund taxation work?


muscleman
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I remember reading a Peter Lynch book saying never to invest in a mutual fund near end of the year, but I don't know any details. Could anyone share some thoughts?

I am interested in buying some Vanguard Money market fund. Since it is money market, do I just enter at $1 and exit at $1, and pay the tax on interest only? Or do I have to pay tax like the equity mutual funds?

 

https://investor.vanguard.com/mutual-funds/list?filterAllAssetClasses=false&filterMoneyMarket=true&filterFiftyThousandAndUp=true&filterLowCostInvestor=true#/mutual-funds/asset-class/month-end-returns

 

I was also considering to buy BIL, but I noticed that there is a 0.01 bid/ask spread, so if I sell it a few months later, i am essentially paying 0.02 bid/ask spread. Is there any bid/ask spread that I have to pay for entering the mutual fund?

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Hi muscleman,

 

The thing with equity funds is that, over the course of the year, the fund will buy and sell various securities within the portfolio.  If this trading activity generates more realized gains than losses, the fund will distribute capital gains to investors at the end of the year, so if you buy units of an equity mutual fund before year end, you're also "buying" the embedded tax liability related to the capital gain that is already reflected in the unit price. This is not an issue with the money market fund as, by definition, securities are short-term and held to maturity.

 

If you are a "foreign" investor, you may want to remember the exchange rate effect which is taxable.

 

Also, you seem to worry about the 0.01 spread on a price of 91.46 (0,01%)? If you are chasing for yield  :), just put your price at the low end and it will likely fill during the day. Maybe this is obvious stuff for you, but you may want to look at how these securities "behave" over time. When you buy a bond, you have to pay accrued interest separately. With these money market units which typically have monthly distributions, accrued interest is not paid but the "market" derives this and the price will typically go up in a pretty linear fashion until the next ex-date is met.

 

For fees, read the prospectus

 

Hope that helps.

 

 

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Hi muscleman,

 

The thing with equity funds is that, over the course of the year, the fund will buy and sell various securities within the portfolio.  If this trading activity generates more realized gains than losses, the fund will distribute capital gains to investors at the end of the year, so if you buy units of an equity mutual fund before year end, you're also "buying" the embedded tax liability related to the capital gain that is already reflected in the unit price. This is not an issue with the money market fund as, by definition, securities are short-term and held to maturity.

 

If you are a "foreign" investor, you may want to remember the exchange rate effect which is taxable.

 

Also, you seem to worry about the 0.01 spread on a price of 91.46 (0,01%)? If you are chasing for yield  :), just put your price at the low end and it will likely fill during the day. Maybe this is obvious stuff for you, but you may want to look at how these securities "behave" over time. When you buy a bond, you have to pay accrued interest separately. With these money market units which typically have monthly distributions, accrued interest is not paid but the "market" derives this and the price will typically go up in a pretty linear fashion until the next ex-date is met.

 

For fees, read the prospectus

 

Hope that helps.

 

Thank you! I do notice that BIL steadily goes up and then at the beginning of each month, drops back when a cash distribution is made.

For money market mutual funds, the price seems to be always $1. If they pay out a cash interest at the beginning of each month, does that mean buying one day before the end of the month is the best?

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