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Author: mjw3786 One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76082  
Subject: Question About Index Funds? Date: 1/22/2007 12:07 PM
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Hi everyone, a friend of mine had a question about Index Funds, and I wasn't sure of the answer, so I thought you kind folks may be able to answer this better than anyone else I could think to ask :)

[So I was looking to invest on an Index fund, more specifically Vanguard's REIT fund. My question is how do i find out when the interest is compounded? Be it annually or monthly?

If im not making that clear, this might help, I read a report on one index fund on msnMoney.com, and it was sayin the fund compounded it's interest each April, before the next fiscal year, which for that particular fund started Mid April.
Well I'm looking at Vanguard right now, and it takes 3,000 for an initial investment, so Im trying to figure out if I need to get my initial 3,000 in real soon to get a piece of the interest chunk for the 2006 year, or am I too late already and should i just wait to get it for 2007?]

Thanks in advance!
Mike
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Author: DeltaOne81 Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 55250 of 76082
Subject: Re: Question About Index Funds? Date: 1/22/2007 12:32 PM
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First, the term you're looking for is dividend payout, or capital gain distribution, or some such. Compounding is more of a mathematical thing and not an 'action' per say.

Second, since its in an IRA, it doesn't matter.

Lets talk about something for a second. Each day the fund calculates its 'NAV' (net asset value) by adding up the value of all the things it holds. This includes cash. As it gets ready to pay out, say $1/share in cash... guess what? That means it holds $1/share in cash. Therefore, when the payout happens, the NAV drops by $1 since the fund no longer has that cash.

So, you get $1 per share in a payout, and lose $1/share in the NAV - meaning the payout itself have no actual effect. Why do it then? Taxes - its income earned for you so you need to pay taxes on it. This can't be done unless there was some transaction in your account. So they pay it out to you so you can be taxed on it as you must be by law. That's it. Since this is in an IRA, that doesn't matter to you.

The value that the fund gains is based on the growth of the companies that it holds, and the cash they receive from them, perhaps. But the cash they send out to you is due to tax law, and is neither a plus nor a minus as far as your return in concerned (in fact, in a taxable account, it would be a minus).


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Author: DoLoop Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 55253 of 76082
Subject: Re: Question About Index Funds? Date: 1/22/2007 12:47 PM
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Lets talk about something for a second. Each day the fund calculates its 'NAV' (net asset value) by adding up the value of all the things it holds. This includes cash. As it gets ready to pay out, say $1/share in cash... guess what? That means it holds $1/share in cash. Therefore, when the payout happens, the NAV drops by $1 since the fund no longer has that cash.

So, you get $1 per share in a payout, and lose $1/share in the NAV - meaning the payout itself have no actual effect. Why do it then? Taxes - its income earned for you so you need to pay taxes on it. This can't be done unless there was some transaction in your account. So they pay it out to you so you can be taxed on it as you must be by law. That's it. Since this is in an IRA, that doesn't matter to you.

The value that the fund gains is based on the growth of the companies that it holds, and the cash they receive from them, perhaps. But the cash they send out to you is due to tax law, and is neither a plus nor a minus as far as your return in concerned (in fact, in a taxable account, it would be a minus).


Thank you. That is the clearest, simplest explanation I've ever heard about why the NAV drops when a fund pays out. I had never really understood that before.


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Author: mjw3786 One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 55255 of 76082
Subject: Re: Question About Index Funds? Date: 1/22/2007 12:48 PM
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DeltaOne!

THANK YOU for your detailed, clear response. Much appreciated!

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