At this time of year, you need to know the ex-dividend date of any mutual fund you plan to buy. By heeding this advice, you’ll avoid some nasty tax and investment return consequences.

To explain why, let me first define “ex-dividend date”. On the ex-dividend date, all mutual fund owners of record become eligible to receive declared dividends and capital gains distributions. If you don’t have the fund by that date, you don’t get paid. You also want to take into account the date of distribution. After that date, you can go ahead and buy your shares without the negative impact on the NAV (Net Asset Value).

At this time of year (October – December), most mutual funds report their dividend and capital gains distributions. You don’t have to worry if you want to buy shares. Such distributions do not affect the share price. However, if you own mutual funds, you should consider the impact of this distribution on the NAV or share value. On the day of the distribution, you will see the NAV of your mutual fund’s shares decrease by the stated dollar amount. In industry parlance, we call it “dividend buying.”

Is that how it works. Throughout the year, cash from dividends paid on shares within the fund and capital gains realized from the sale of assets are accumulated and added to the fund’s cash balance or reinvested in shares by the fund manager. At the end of the year, the fund must distribute at least 95% (?) of dividends/realized capital gains not reinvested in new securities. Normally, the funds declare this distribution in the months of October and November.

At the end of the year, the fund’s NAV reflects the value of all the investments it contains plus the initial cash balance and accumulated cash resulting from dividends and capital gains. When the fund manager distributes dividends and capital gains, the NAV reduces the corresponding amount. That’s fine for people who have owned the fund for most of the year. They enjoyed NAV appreciation that resulted from investment growth, dividends, and realized capital gains. An investor who buys just before the ex-dividend and distribution dates has bought cash value. When the fund distributes the cash, the new shareholder sees the value of their shared fund decrease, receives part of the investment, and then pays taxes on, in essence, their own money from it! It’s not a good deal.

A look at an example will show you why you want to avoid buying dividends. Suppose the ex-dividend date is tomorrow and you buy shares at a NAV of $25. The fund declares a dividend of $3.00 per share. If you do, it means that tomorrow the fund distributes $3.00 from the NAV, so your shares are now worth $22 instead of the original $25. You now owe taxes on $3.00 per share even though you didn’t enjoy the price appreciation you would have if you had bought earlier in the year.

You can see that you lose in this situation. You should avoid buying dividends. Instead, wait until after the distribution date to buy your shares. Then you can enjoy any appreciated price all year long and pay no tax on your own cash back!