InvestorKeep sends you an alert every time you receive a capital gains distribution. It’s nice to know you received money, but what exactly are you receiving? Capital gains distributions typically happen at the end of the year when mutual and exchange-traded funds (ETF) distribute proceeds from the sale of assets (stocks, bonds, etc.). When you receive the funds, you have two options: keep the money, or reinvest it in additional shares of the fund. Either way, you have to pay taxes on the distribution.
The advantage of capital gains is that they are taxed as long-term capital gains (even if you have owned the fund for less than a year). Short-term capital gains are taxed at income tax rates as opposed to long-term capital rates which receive preferential treatment. Depending on your tax bracket, you will pay 0%, 15%, or 20% on the distribution. This disadvantage of capital gains distributions is that they lower the net asset value (NAV) of the mutual fund. NAV of a mutual fund is all the assets minus liabilities divided by the outstanding shares. This is the value of your individual shares of the fund. Since the fund is distributing assets, it is naturally decreasing in value. However, this does not change its overall return to you as the investor because the real return is the distribution plus the current value of the shares.
When you are notified of your capital gains distribution, it may be worth a conversation with your financial professional to see if you should reinvest in the current fund, take the cash for yourself, or reinvest elsewhere.