Question: 
If I buy a mutual fund at the end of a year, are there expenses that will be assigned to my shares even if I have owned them only a short while?

Answer:
The answer to your question is yes there are such expenses, but it's not a problem. But if you had asked the question a little differently, we'd be able to alert you to a significant potential problem with buying fund shares near the end of the year.

The answer to the question you asked, about expenses, is pretty simple. All mutual funds have operating expenses, and they are almost always stated on an annual basis, such as 1 percent. But these expenses are pro-rated and taken out a little at a time, every day. That means you are charged for every day you own the fund, but only for the days you actually own it.

So if you have $50,000 invested in a fund with a 1 percent expense ratio, a year's worth of those expenses (if you ignore any appreciation in the fund) would cost you $500. But on the basis of 365 days, that would amount to $1.37 per day. This calculation, by the way, has nothing to do with the start or end of a calendar year.

However, there's another thing to watch out for when you buy a fund late in the year: capital gains distributions. Mutual funds routinely buy and sell securities, sometimes making a profit and sometimes taking a loss. By law, the funds don't pay any taxes on their net capital gains; instead, they have to distribute those gains to shareholders, who must pay taxes on them.

Funds traditionally make capital gains distributions once a year, usually in December. Here's a simple hypothetical scenario to show why this is a potential problem. Imagine a fund has sold stocks through the year and has accumulated net capital gains worth $2 per share, or about 10 percent of its portfolio.

Let's say you invest $10,000 in this fund on December 6, paying $20 a share for it, so you have 500 shares. Two weeks later, on December 20, the fund declares a capital gains distribution of $2 per share. This means that the fund pays you $1,000, either in the form of a check or by reinvesting the $1,000 in more shares.

If you own the fund in an IRA or some other tax-sheltered plan, this is not a problem.

But if you own the fund in a taxable account, you will suddenly have $1,000 in capital gains income on which you will owe taxes. In effect, the fund will refund $1,000 of your purchase price to you (this is true whether you take the cash or reinvest in more shares) and you will have to pay taxes on it.

That is patently unfair, because you did not benefit from those gains, you purchased them. But that's the way the tax laws are written, period.

Therefore, it's a good idea whenever you are going to buy a fund to check out the dates and estimated values of any upcoming distributions. In the example above, if you waited until December 21 to buy the fund, you would avoid any tax liability for the previous day's distribution. Most mutual fund companies will tell investors (at least those who ask) ahead of time the expected timing and amount of upcoming distributions. That's worth making a phone call any time you are about to invest a substantial amount in a taxable account, and especially in December.

Often, you can find this information on a fund company's Web site. But you won't always get much advance notice. For instance, Janus posted its final distribution figures at www.Janus.com on December 5, just 10 days before distributions were to be made on its equity funds.

In the Janus Mercury Fund, for example, shareholders were facing distributions (income plus capital gains) of $3.27 per share. Based on the fund's price ($34.64 on December 4), that might amount to 9.4 percent of the fund's net asset value.

So if you invested $10,000 in that fund in that fund in a taxable account during early December, you could be saddled with $940 or so of taxable income, without any corresponding benefit.

These distributions can be a major annoyance for existing shareholders, too. Consider the case of Janus Venture, a small-cap growth fund that lost 46.5 percent of its value from January 1 through December 4. Patient, loyal shareholders are likely to get an unpleasant surprise when they discover that they've been required to take distributions of $14.26 a share, or 21.9 percent of what the fund was worth on December 4.