Tangerine’s Joe Snyder addresses the most frequently asked questions about Mutual Fund distributions, starting with a simple explanation of what they are.
One of the trickier things to understand about investing, and mutual funds specifically, are distributions: how they work, what they mean to you, the investor. So today we're going to tackle that slightly more technical topic.
What Are Mutual Fund Distributions?
Mutual fund distributions are payments to you, the investor, for any income the fund has generated throughout the year. They can be interest, dividends or capital gains. Sometimes they're paid out quarterly; often they're paid out annually.
Why Does My Unit Price Drop By When My Distributions Are Paid?
Your unit price is going to drop by the amount of the distribution, because the distribution, again, is a payment to you for money that's been reinvested in the fund throughout the year, for example. So your unit price drops by the amount of the distribution. If it was $10, then on the day of the distribution, it's going to drop by, if the distribution was 10 cents, it will drop by exactly 10 cents, and the new unit price will be $9.90, provided there has been no market movement by then that day.
What Happens to the Number of Units I Own?
The number of units you own is going to increase because when you pay the distribution it's used to buy you additional units of your fund at the new lower price.1
What Happens to the Adjusted Cost Base?
The adjusted cost bases are really important to understand, so let's define it first. The adjusted cost base (ACB) is essentially the average unit base price that you've paid over the lifetime that you've owned that investment. Over time you might buy at $8.00 a unit when you start. Say, the market goes up, your next purchase is at $8.50 a unit, the market goes up more and your next purchase is at $9.00 per unit. Then the market goes down and your next is at $8.75 a unit. Essentially, depending on how much you're buying, you're getting an average unit price of $8.56, and that's your adjusted cost base.
Now when you're paid a distribution, your adjusted cost base will decrease a little bit as well because the income you're receiving is being used to buy you additional units at a lower price; therefore it's going to reduce you ACB.
Are Distributions Taxable?
Distributions are taxable in non-registered or taxable accounts. They are not taxable in RSPs, TFSAs or RIFs, so basically any registered accounts. You receive a T3, or in some cases a T5, tax slip, which is going to tell you the combination of potential interest, dividends, capital gains, or return of capital that your distribution has paid you.
Is There Any Change in the Dollar Value of My Investment After a Distribution is Paid?
So the interesting thing about distributions is they don't affect the dollar value of your investment, so if your account was worth $1,000 yesterday and then distribution was paid at the end of the day, today it's still going to be worth $1,000. The difference is you're probably going to have a few more units because your distribution was used to buy you additional units of the fund at that lower price.2
Can You Give Us an Analogy?
So mutual funds often act like a person. So here's what I mean: as a person you might have a savings account, and throughout the year you might earn some interest in that savings account. The thing is you don't have to pay tax on that interest until you get your tax slip and you file your tax return. Mutual funds work the same way: the things that they buy, securities they own, generate income throughout the year, but there's no tax on it. At the end of year, they distribute that back to you and me, the unit holder, and then we have to pay tax on it when we file our tax returns.
1 Specifically for Tangerine funds, as the distributions are automatically reinvested. Other fund companies give clients the options of taking their distribution as a payment.
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