I mentioned this last year in my post 3 Reminders About Year-End Mutual Fund Distributions. I see the conventional wisdom “don’t buy a distribution” is still going strong. Vanguard reiterated this conventional wisdom in its blog post The record date: Not a tune you can dance to in early December.
But the conventional wisdom is wrong. I patiently waited until I can have a real life example.
After Vanguard published the blog post, Ella posted on the Bogleheads investment forum and asked if she should invest in two ETFs right away or wait until the ex-dividend date.
The ex-dividend date is the date when the investor will not receive the dividend. Not receiving the dividend means not paying the tax on the dividend now but paying a higher capital gains tax in the future. In effect, the tax is deferred, but not avoided.
Ella got the conventional wisdom answer from the forum participants: don’t buy a distribution; wait until the ex-dividend date. One of the replies came from Taylor Larimore. Taylor is a respected forum leader and the lead author of two Bogleheads books. On December 10, Ella decided to wait.
The two ETFs Ella asked about were Vanguard Total Stock Market ETF (ticker VTI) and Vanguard Europe Pacific ETF (ticker VEA).
On December 10, VTI traded between a low of $55.61 and a high of $55.97 a share. Let’s take an average and call it $55.79. The ex-dividend date for VTI is December 22. On that day, VTI traded between $56.30 and $56.59. Let’s take an average and call it $56.45.
If Ella bought VTI on Dec. 10, for every $10,000 she could have bought $10,000 / $55.79 = 179 shares. Those 179 shares were worth $56.45 * 179 = $10,105 on Dec. 22. In addition, she would also receive a dividend of $0.358 per share. That’s $0.358 * 179 = $64 in dividends. Together with a leftover $13 from the share purchase, Ella would have $10,182 in shares and cash if she bought on Dec. 10, versus $10,000 if she bought on Dec. 22.
The conventional wisdom market timing advice cost Ella $182 for the sake of deferring tax on the $64 dividend, which comes out to $10 at 15% qualified dividend tax rate. Giving up $182 to defer $10 is penny wise pound foolish.
The story on VEA is a little better. VEA’s ex-dividend date was December 24. Doing the same math shows Ella was worse off by $98 for the sake of deferring $34 tax.
Although the story “don’t buy a distribution” sounds credible, its base assumption “ignoring market appreciation/depreciation” is false. The market appreciation/depreciation is many times the size of the tax effect on distributions. It can’t be ignored. Worrying about the tax effect while ignoring the market movement is missing the forest for the tree leaves.
Of course someone can argue the market could’ve gone the other way and Ella would be better off waiting. But that’s precisely my point. Whether some one is better off waiting is determined by the market movements, not by buying before or after the ex-dividend date. Trying to be clever about the distribution and the ex-dividend date is unproductive in the face of market movements.
If an investor is going to time the market on the purchases, he/she should time on market movements, not on distributions and ex-dividend dates, because the former’s effect is a magnitude larger. Of course we all know one shouldn’t time the market. Therefore, don’t worry about the distributions and ex-dividend dates when their effect is just a tiny blip overwhelmed by daily volatility.
Refinance Your Mortgage
Mortgage rates hit new lows. I saw rates as low as 3.25% for 30-year fixed, 2.625% for 15-year fixed, with no points and low closing cost. Let banks compete for your loan. Get up to 5 offers at LendingTree.com.