by Harry Sit on January 3, 2011 7 Comments

Financial advisor Allan Roth has a pet peeve against the Associated Presss habit of reporting the raw S&P 500 index changes as if they are the U.S. stock market returns. He argues the true U.S. stock market returns should (a) include dividends; and (b) include small caps. I agree with him, but the media dont listen. Every year Allan writes a new article pointing out the same thing.

I, on the other hand, have a pet peeve against the conventional wisdom of timing mutual fund purchases around year-end distributions. Every year in late November to early December, as predictable as clockwork, there will be articles telling people to hold off investing in mutual funds until after the year-end distributions. Otherwise you will pay taxes on gains you didnt have, these articles warn the investors.

Here are some examples:

For the most part, if you are investing through index funds or ETFs (why arent you?), timing purchases around year-end distributions is either irrelevant or penny wise pound foolish.

I say its irrelevant because most investors invest in tax advantaged accounts, like a 401k or IRA. The tax nuance on year-end distributions just doesnt matter in those accounts. Considering topping off an IRA contribution? Go right ahead. Dont worry about year-end distributions.

For taxable accounts, I gave some real world examples in my previous posts 3 Reminders About Year-End Mutual Fund Distributions and Conventional Wisdom Don’t Buy a Distribution Is Wrong. The same thing happened again this year. Putting off purchases until after year-end distributions made investors worse off. A lot worse in some cases.

Since we got the explicit instruction avoid purchasing year-end distributions from Vanguard, the mutual fund company, I looked at two popular broad market index funds from Vanguard: Vanguard Total Stock Market Index Fund (VTSAX) and Vanguard Total International Stock Market Index Fund (VTIAX). I also looked at one other Vanguard fund that had the largest year-end distribution relative to the fund price. Thats Vanguard European Stock Index Fund (VEUSX), which distributed more than 4.5% of its NAV on December 20, 2010.

I looked at three scenarios:

1. Buy on Dec. 15, the day Vanguard published its warning
2. Buy on the Record Date, the worst possible date according to the conventional wisdom
3. Buy on the day after the Record Date, as recommended by the conventional wisdom

Heres a summary of what happened for a $10,000 purchase under each scenario. Its not clear at this point how much of the distributions are qualified dividend versus non-qualified dividend. For simplicitys sake Im assuming they are all qualified dividends, taxed at 15%.