What stocks to invest in
It has to do with taxes on mutual funds and ETFs, whose tax years normally end in October.
That wasn’t always true. Up until the late 1980s, the tax year for mutual funds typically ended on December 31st. That, however, gave the funds no time to close their books and send out the required taxable distributions (basically, all of the income plus realized gains) to shareholders before the end of the calendar year. Often, preliminary distributions were made in December and supplementary ones in January. This was expensive …and the late distributions meant that part of the money owed to the IRS was pushed into the next tax year.
So the rules were changed in the Eighties. Mutual funds were strongly encouraged to end their tax years in October, and virtually every existing fund made the change. New ones followed suit. That gave funds two months to get their accounts in order and send out distributions to shareholders before their customers’ tax year ends.
getting ready to distribute
How do funds–and now ETFs–prepare for yearend distributions?
Although it doesn’t make much economic sense, shareholders like to receive distributions. They appear to view them as like dividends on stocks, a sign of good management. They don’t, on the other hand, like distributions that are eitherminiscule or are larger than, say, 5% of the assets.
When September rolls around, management firms begin to look closely at the level of net gains/losses realized so far in the year (the best firms monitor this all the time). In my experience, the early September figure is rarely at the desired target of 3% or so. If the number is too high, funds will scour the portfolio to find stocks with losses to sell. If the number is too low, funds will look for stocks with large gains that can be realized.
In either case, this means selling.
Some years, the selling begins right after Labor Day. In others, it’s the middle of the month. The one constant, however, is that the selling dries up in mid-October. That’s because the funds’ accountants will ask that, if possible, managers not trade in the last week or so of the year. They point out that their job is simpler–and their fees smaller–if they do not have to carry unsettled trades into the new tax year. Although the manager’s job is to make money for clients, not make the accountants happy, my experience is that there’s at least some institutional pressure to abide by their wishes.
Most often, the September-October selling pressure sets the market up for a bounceback rally in November-December.
What stocks to invest in