Timing for small stocks and mutual funds

The Investment Reporter, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846
Small stocks do best in January. So if you’re in no hurry to sell, wait until January to do so. If you want to buy a small stock, do so before January. Buy mutual funds after they distribute their gains. Otherwise you’ll faces taxes on gains you didn’t even earn.

Small-company stocks do best in January. It’s part of what’s known as the ‘January Effect’.

From 1926 through 2012, American small-company stocks generated average returns of about 5.4 per cent in January. The first month of the year is by far the best one for small-company stocks.

As a result, if you plan to sell a small-company stock, it’s best to do so in January—provided there’s nothing wrong with the company. In that month, your small-company stock will more likely fetch a higher price. But if there is something wrong with the company, then sell immediately.

If you want to buy a small-company stock, by contrast, then it’s best to do so before January. That way you’ll likely buy it before the price goes up and you’ll likely have a profit in January, if not sooner.

Avoid taxes on gains you don’t earn

With mutual funds, it’s best to buy after they distribute and pay out their gains. Otherwise you’ll face taxes on gains that you didn’t even earn.

When a mutual fund has unrealized gains (‘paper’ and not-yet-taken profits), its units will reflect these gains. When you buy the units, you’ll have to pay the net asset value, which includes the unrealized gains. You’ll profit only from gains after you buy the units, not the former gains. The trouble is, if the mutual fund distributes gains soon after you buy it, then you’ll face taxes on profits that the mutual fund made before you bought the units.

To avoid this tax trap, it’s best to buy a mutual fund’s units after it has made its distribution. That way when you face taxes on future gains, at least you’ll have earned them.

This rule, however, applies only to what is called ‘unregistered’ money. If you buy mutual funds inside a RRSP (Registered Retirement Savings Plan) or a RRIF (Registered Retirement Income Fund), then distributions don’t matter, since they’re non-taxable.

The same goes for TFSAs (Tax-Free Savings Accounts). Whether or not the mutual fund distributes its gains, the mutual fund unitholders will face no taxes within a TFSA.

 

The Investment Reporter, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846