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Like to Buy Now but Avoid Year-End Tax Bugaboo? A Few Possibilities

November 08, 1998|PAUL J. LIM

The last two months have been a great year for stocks.

Since the market bottomed at the end of August, the Dow Jones industrial average of blue-chip stocks has surged 18.5%. The slightly broader Standard & Poor's 500 index has advanced slightly more.

And the best news of all: Small-company stocks aren't just participating in this end-of-the-year rally, they're leading it.

The bandwagon has started rolling. Think it's time to join it?

Perhaps. But the big question--especially for those who have been hiding in ultra-safe money market funds--is where to get on.

The possibilities abound: Growth funds, tech funds, telecom funds and small-cap funds all have done well in recent weeks. But no matter which type (and, ultimately, which fund) you choose, look before you leap. Because waiting for you, along with that hearty welcome from your fund, may be an equally big taxable distribution.

Every year, funds that have realized capital gains--perhaps by selling some of their holdings during the year--distribute those gains to shareholders.

Say, for instance, that a fund is sitting on capital gains of $500,000. If there are 200,000 shares outstanding at the time of the distribution, investors would receive a distribution of $2.50 a share.

Now imagine you decide to invest $2,500 in such a fund just prior to the distribution. If that fund's net asset value, or NAV, per-share price is $25, you'd receive 100 shares. Whether you reinvest that distribution (at $2.50 a share, you'd receive another 11 shares) or take the $250 cash, you'd still owe taxes on that amount.

"That's like giving yourself a load but the government gets the commission," said Russ Kinnel, equity editor for Morningstar Mutual Funds.

Had you waited another couple of days, you would have simply been issued 111 shares of the fund.

(Note that this will not be a problem in tax-deferred accounts.)

Susan Belden, editor of the No-Load Fund Analyst newsletter in Orinda, Calif., says a decent rule of thumb is to avoid jumping into funds that are about to make a distribution representing 5% or more of the fund's NAV per-share price.

You can do that, by and large, by sticking with index funds, which rarely sell any of their holdings and therefore don't realize many capital gains.

Or you can go with funds that have already made their distributions.

A word of caution, though. Just because a fund made a distribution earlier this year doesn't mean it won't make another. Take Clipper, which realized tremendous capital gains throughout the year, as it did a ton of selling to build up cash. In August, the large-cap value fund distributed gains of about $11.50 a share to its investors. But it's not done. In December, the fund projects another distribution of $2 or more per share, subject to change.

Here, then, are some well-known solid funds that have already distributed most, if not all, of their gains for the year--or that aren't expected to make much of a distribution at all:

* John Hancock Regional Bank Fund. Investors who have wanted in on this five-star-rated financial services fund are in for two pieces of good news: First, the fund just reopened to new investors. Second, it's already announced a distribution of $1.47 a share. The record date was last Tuesday, which means only investors who owned shares then will get hit with it.

* Oakmark. This $6.8-billion large-cap value fund issued a sizable distribution of $4.03 a share in August in hopes of clearing the decks to attract new investors. To be sure, the fund slipped in 1996, when it fell into the bottom quartile of its peers. But it recovered the following year. And with five-year annualized returns of 18%--which beats its average peer by 2 percentage points--it's worth a look.

* Muhlenkamp. Ron Muhlenkamp's $176-million portfolio isn't expected to make a distribution this year. In fact, thanks to its low 14% turnover, the mid-cap value fund has made only two capital gains payouts--amounting to just 36 cents--over the last decade. That's yet another reason to consider the fund, which has finished in the top third of its peers over the last one, three and five years by investing in only the most profitable companies.

* Delaware Trend. Morningstar analyst Scott Cooley notes that in July and August, when stocks tanked, Delaware Trend fell 8 percentage points less than its peers. Year-to-date, this small growth fund, which already made its distributions for the year, has fallen just 3.7%. That's 10 percentage points less than what the typical small growth fund has lost.

* T. Rowe Price Blue Chip Growth. OK, this $3-billion fund is still due to make a distribution, with a record date of Dec. 15. But because of its low 24% turnover, this large-cap fund is expected to pay out only 37 cents a share in long-term gains. Over the last five years, the fund has delivered annualized gains of more than 21%.


Times staff writer Paul J. Lim can be reached by e-mail at

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