Can I Owe Taxes when my Return is Negative?

Barbara’s first question was. “My mutual fund lost money last year. Why do I have to pay taxes on it?” Barbara is a very nice lady and she is always very friendly and open with me. She normally isn’t prone to complain, but in this meeting, she just couldn’t understand how she could get a tax bill from an investment that had a negative return in 2018. To Barbara’s way of thinking, it just doesn’t make sense to have to pay taxes on something that is not worth as much at the end of the year as it was at the beginning. But she still received her 1099-Div for the $1,500 of dividends her mutual fund paid out at the end of 2018. However, her $100,000 mutual fund had decreased to $95,000 last year. So how can an investment that lost $5,000 send you a tax form that claims you made $1,500? Barbara was confused and a bit agitated. At first she didn’t really want an explanation. She needed to vent a little. But once she had said her piece, she was ready for an explanation she was sure I didn’t have. With thirty-five years in investments and asset management, I had seen this many times. So while it was no mystery to me, it still took some explaining to get Barbara comfortable with what had happened. A mutual fund is a company that uses the investment from hundreds or thousands of people to buy the stock of many different companies. That way the investors in that fund get diversification without having to buy the individual stock of all those companies the mutual fund holds. Many of these companies may pay a dividend each quarter to their stock holders. The mutual fund, being a stock holder in that company, will collect the dividends for the number of shares they hold. Once they collect all the dividends from those companies, they must then turn around and distribute those dividends to THEIR share holders. If Barbara paid $10.00 a share for 10,000 shares of that mutual fund last year ($100,000), and the price declined to $9.35 ($93,500), but she re-invested the $1,500 dividend (buying an additional 160.43 shares), she now has a value of $95,000 in the mutual fund. And she gets to add the $1,500 dividend to her cost basis. So when she sells those shares, she’ll have to pay taxes only on the amount she gets above $101,500. Should the fund value rise this year to $11.00 a share, Barbara will have a value then of, not $110,000, but $111,765 because the additional 160.43 shares she bought at $9.35 have also increased to $11.00. So Barbara will not lose the benefit of the $1,500 dividend she has to pay taxes on. In fact, once the shares go up, if they do, she will gain a nice benefit of adding additional shares to her portfolio at a lower price than she paid for her original shares. Sometimes, what at first appears to be bad turns out to be good. It just takes patience and understanding.