So, the beginning of 2019 I started taking a more active role in my 401K (through my employer). I upped my per pay contribution significantly and moved it from the target fund it was in into a Vanguard 500 index fund.
In the one year since I began this, my 401K is up a total of $9233.17 (this is not the total of the 401K, just what it gained in one year), the total per pay contribution (mine and my employer) is $6,446.22 and the dividend total is $216.36.
So, adding the total per pay contribution and dividend total, we get $6662.58. Where did the other $2570.59 come from then? The one year rate of return is listed as 23.51%, which seems to be about what is is actually up. But why is the dividend total listed as only $216.36?
The $2570.59 is the amount by which your Vanguard shares have increased in value over the year (taking into account your new purchases during the year).
Yup. You can look up the share prices of the fund you’re invested in to see how it’s changed over time. Here’s a link. You may not be in this particular class of that fund, but the changes should track pretty closely.
Dividends are distributions of income by the fund. They are separate from the change in the market value of the investment.
Total return for a mutual fund includes: capital appreciation (change in value per share of the fund), capital gains distributions (parts of the fund being sold for a gain/loss in order to track the index or balance the fund in some way), and dividend distributions (dividends paid by the stocks underlying the fund).
I would assume that your statement should include capital gains distributions as well as dividend distributions, but perhaps they are combined. In either case they were almost certainly used to purchase more shares of the fund that generated the distribution.
ETA: On preview I looked it up and I guess the Vanguard 500 fund did not have any capital gains distributions this year. Something more active or not purely indexed like that fund would likely also have capital gains distributions.
I don’t mean to be condescending but I’ll give a simplistic explanation.
Three things can happen to stocks that affect the value of your account.
They go up in value. The market price goes up, your share price goes up, your account value goes up. (All of this can happen in the down direction, too.) This is what is sometimes called a paper gain/loss because the price of the stock is all on paper. You can’t get any money for it until you sell it. When this happens there is no impact on your taxes. You only have to pay taxes in the two cases below.
You get capital gains. The fund sells some shares of stock for more than they paid for it. When this happens, the fund gives you a statement at the end of the year so you can declare the gains on Schedule E of your tax return. Gains earned after you have held the stock longer than a year are taxes at a lower rate than your ordinary income. Usually the fund will use this money to buy more shares of the fund on your behalf, although in some cases you can opt to take capital gains as a cash payment. (This can happen in the loss direction, too.)
The company issues dividends. A mature company will often distribute part of its profit to stockholders as a cash dividend, based on a fixed dollar amount per share. When this happens, the fund gives you a statement at the end of the year so you can declare the gains on Schedule B of your tax return. Dividends are taxed at the same rate as your ordinary income. Usually the fund will use this money to buy more shares of the fund on your behalf, although in some cases you can opt to take dividends as a cash payment.
I do not know the details but I think for an indexed fund like this one will only buy and sell stocks resulting in gains/losses if S&P adds or removes stocks from the index.
There are no capital gains and no Schedule E for a 401k. I don’t know why they would break out dividends, unless it’s just standard reporting for their funds. If it’s in a 401k, it’s all tax deferred, and is all taxable as income when it comes out, regardless of whether the growth came from interest, dividends, or capital gains.
As far as I know, all capital gains and dividends in a 401k fund are automatically reinvested in that fund. I don’t think they make distributions, or else you’d have a growing money market fund in your 401k.
For a 401k, the reports of distributions of dividends and capital gains are not for tax purposes. As you say, they are irrelevant. Rather, they are simply so that you can keep track of how many shares of the fund you own. Generally a dividend distribution is reinvested in the fund, so now you have more shares.
The distributions are still reported because many people invest in the Vanguard 500 outside of a tax-deferred account. So in those cases, the distributions matter because they are taxed as investment income on your 1040, regardless of whether you take the cash or choose to reinvest in the fund.
OP, since 401k are tax-deferred, the $2570.59 from the share price appreciation plus the $216.36, together, is your total gain for the year. That $216.36 got combined with the contributions, so you wound up getting an additional 0.75 shares (or some such fractional share) compared to if you didn’t get the dividend.
The $2570.59 is unrealized capital gains. Basically, the Vanguard share price went up, so each share that you have is worth more.
This sounds like you are saying that when you sell the shares, there is no impact on your taxes. That is true in this case because these shares are in a 401(k) and the income taxes are deferred until he takes money out of the account. Generally, selling mutual funds in a taxable account is a taxable event.
Mutual funds don’t distribute capital losses. If they experience a capital loss in a particular year, they make no capital gain distribution and they carry the capital loss forward to offset future years’ capital gains.
Mutual funds trade shares and experience capital gains and losses all the time. You are correct that index funds buy and sell shares when the index changes but they trade routinely because of investors. When investors buy shares of the mutual fund, the mutual fund takes the investor’s money and buys stock or other securities. When investors sell shares of the mutual fund, the mutual fund has to sell the stock or securities to pay the investor. These transactions generate capital gains and losses all the time, so the fund may have capital gains in any year, regardless of whether the index changes.
You are right that the amount of the dividend and capital gains distributions are irrelevant to a person that holds mutual funds in a 401(k) but a mutual fund must distribute its capital gains and dividends each year in accordance with IRS rules. The mutual fund is used by both taxable and tax deferred accounts and the IRS needs to keep track of the distributions to taxable accounts so they can be taxed appropriately. So, both taxable and 401(k) investors get capital gains and dividend distributions from the mutual funds.
That was a smart move to increase your contribution and switch to Vanguard 500. Don’t panic when share prices decline rather than increase as recently. You will merely be buying in at a lower price. Look up “Dollar Cost Averaging”.
Do you have a 5 letter symbol? Mutual funds issue several different share classes and many are restricted to institutional accounts/retirement accounts.
Dividends are paid by companies that make up the mutual fund. If you owned just an individual stock and it paid a .35 divided, then your account balance would go up by .35 per share that you owned.
Capital gains are the share price appreciation realized when a mutual fund has to sell shares in a company to remain balanced. They can also occur with a company merger where the acquiring company pays a set dollar amount to acquire the received company.
It’s extremely common in retirement accounts to reinvest the dividends and capital gains. They are not a taxable event inside a retirement account.
Since everybody else seems to be ignoring your last question, I’ll take a crack at that one.
100+ years ago, it was very common for reputable companies to issue high dividends on a regular basis. These were known as “widows and orphans stocks” because a significant sum of money invested in these companies would produce enough income just from dividends for a person to actually live on.
But corporate thinking has changed. Many companies still pay dividends, but most are much smaller relative to the company’s size and income. Most companies prefer some combination of the following: (A), save cash for some unspecified future purchase and/or rainy day; (B), use the money to buy back their stock; or (C), spend many, many millions of dollars on compensation for their top executives.
That’s why your dividend figure is so much smaller than all the other figures.
Thank you for this correction. I was not thinking about the tax implications for a 401(k) even though that was explicitly what the OP was asking about. My apologies.
My wording was poor. I meant that in case #1 where the share price goes up by itself is not a taxable event. I put those words in the wrong place. Thank you for the other corrections as well.
Congratulations! You will look back on that move as one of the wisest in your life. Keep it going.
One way to keep it going is with each raise, increase your contribution (up to the max for a 401k). No need to spend every raise, after all, you lived without it last month…
Here is an article with some ideas. I like the suggestion to spend a percentage of each raise or bonus equal to twice your years to retirement and save the rest.
The main reason companies pay out a smaller % of profit as dividend than they used to is tax treatment. For individual 401k/IRA money or institutional accounts like pension fund which don’t get taxed on current investment returns it doesn’t matter. But for stocks held in taxable accounts a buyback is basically the same as a dividend (company sets asides a portion of profit to pay out in cash) but it’s not a taxable event for the stockholder until they sell the shares. A dividend is taxed when paid out. That would always have saved (delayed) taxes, but market custom has only gradually came around to preferring this, in part because of the layman’s assumption suggested by the tone of your post, that if money isn’t being paid out in dividend, there must be some self dealing type reason for that by the company’s management. But it costs investors higher taxes to insist managers pay out a high % of earnings as dividends, buybacks are a more tax efficient version of a dividend.
Another reason dividend yields are so much lower than they used to be (were at one time ca. 4% now less than 2% for S&P) is in part just because the market value stocks more highly relatively to a $1 of earnings than used to be the case. If a company makes the same profit, pays out the same % of that profit as dividend but the market values the shares 50% higher, the ‘dividend yield’, dividend per share divided by share price, automatically goes down by 33% (1-1/1.5).
Executive compensation is largely orthogonal to the question of dividends. A lot of it is also paid out in shares not cash. Also if high executive compensation was destroying corporate value net, it would seem it would cause the stock market in the country with (generally) highest executive pay to lag stock markets in countries withe generally lower executive pay. It’s been the opposite, US stock market’s total value is now over 1/2 that of the total world stock market, significantly higher than it used to be, and in a period where US GDP as % of world GDP has shrunk significantly. There are definitely socio-political issues with executive from certain socio-political POV’s, and perhaps actual non-political corporate governance reasons to worry about executive pay in US corps. But it’s not as simple as ‘investors used to get that money as dividends, now executives get it’.