On Thursday, December 14, my main holding tanked 12%.
Thursday as a whole was a good day in the stock market, the DOW closed positive for the fifth day in a row, and set a record close in the process. The Fed Hiked the Benchmark Interest Rate, but investors did not panic, because it was widely expected. The S&P 500 declined (only 0.05%) and on a whole, the stock market didn’t make any massive jumps or falls.
My portfolio consists mainly of PRGFX, and has a few individual stocks. (view more info on my portfolio here) While not the most diverse, the portfolio has given me great long and short-term growth. But, because I am only long in a limited amount of investments, any movement (big or small) effects my overall account value.
However, my account rarely moves more than 3% per day. Why? Well, even though PRGFX is my main holding, it is a diversified mutual fund. Think of it like a folder that contains a bunch of stocks. I own the folder, and in turn have exposure to all the assets in the fund. PRGFX is fairly diversified in its assets, owning a verity of positions across multiple sectors. In addition, the fund only has 37% of its funds in the top 10 holdings, which is pretty good. That means that 53% of the fund is exposed to assets outside of the top 10 holdings, and therefore is fairly diversified.
I bought into this fund a few months ago because I wanted the diversification that it offered, while also having an ‘aggressive growth’ mix of stocks. After shopping around for some aggressive growth funds, PRGFX shone as the best fund for me. I liked the stocks and assets that it was invested in, and also its notable growth and low volatility. It’s also one of the more popular funds, managing about $40 Billion in assets.
Morningstar gives PRGFX a five-star rating, its one of the top growth funds in the U.S. News’ mutual fund reviews, and for the past year or so has had a Strong Buy or Buy Rating from Zacks. By all accounts, this mutual fund is very, very good.
Mutual fund data updates each day after market close, so while I do check my individual stocks throughout the day, I can’t see any movement in my mutual funds. That Thursday evening, I was reviewing my stocks and PRGFX caught my eye. It’s usually green, and today was red (that in its self was pretty surprising). Then I saw; it was down a stunning 12%. I don’t think I’ve ever taken a loss that big in the stock market, ever.
At first, I couldn’t believe it. Thinking rationally, the fund is so diversified, the only way that it could move like that would be if one of its top holdings went bankrupt, or some other crazy event like that occurred. I checked all of its major holdings, and nothing was amiss.
Then, I checked the news. Maybe T. Rowe (the company that manages the fund) had an issue. Was there a management change? The news had absolutely nothing. There was no logical explanation for my main holding suddenly loosing over 10% of its value.
At that time I was very disappointed and still didn’t know why it happened. But then I realized this; It happened and I can’t change it. Live and Learn (hence my Instagram post).
I decided to not stop until I figured out why this massive change in value occurred. I knew that I needed to learn from this, so it would never happen again.
On Friday, I reviewed the holdings and news again – nothing had changed. That afternoon I signed into my brokerage account to see my actual losses, and was surprised to see that my account’s value was the same (actually a bit more) than the last time I checked. I went to my account activity to see if someone had transferred any money into it, or something else happened.
There, in account activity was one sentence that absolutely made my day. “LONG-TERM CAP GAIN as of 12/14/2017 T ROWE PRICE GROWTH STOCK”. The activity section of my brokerage account said that I had received this as cash and reinvested it in the fund. ‘Coincidentally’, it was the same amount of money that I had lost the previous day.
Usually, reinvestment occurs with dividends, but this fund has a very low yield, that couldn’t support the amount of cash that was reinvested in the account. The cash wasn’t the distribution of dividends, it was the distribution of Long-Term Capital Gains. I remembered reading about these previously, but didn’t remember reading that they affected the underlying value of the fund.
Heres a quick overview of Capital Gain Distributions (sourced from American Funds, a site with tons of great tools and information):
[learn_more caption=”What Is A Capital Gain?”] “When an investor sells a capital asset — such as a stock or a bond — for more than the purchase price, the investor experiences a capital gain, or, in other words, makes a profit. For example, if a stock is purchased for $100 and later sold for $120, the capital gain is $20. When a mutual fund sells securities at a profit, the sale also creates a capital gain. There are two types of capital gains — short-term and long-term. Net short-term capital gains are distributed to investors as income dividends and are subject to ordinary income taxes. The maximum tax rate on long-term capital gain distributions is 20%. This rate does not include the 3.8% surtax applicable to net investment income for higher income taxpayers.”[/learn_more]
[learn_more caption=”Why Do Mutual Funds Pay Capital Gains Distributions?”] “When a mutual fund sells a holding, it receives any profit, or capital gain, that results from the sale. Mutual funds are required by law to distribute virtually all gains to their shareholders in capital gain distributions. These distributions, which often occur once or twice a year, are made primarily for tax reasons.”[/learn_more]
[learn_more caption=”Why Does The Fund Value Drop When Mutual Funds Pay Capital Gains?”] “Fund managers buy and sell securities throughout the year, sometimes at a profit, sometimes at a loss. When profits outweigh losses, they accumulate and contribute to the rise of the net asset value (NAV), or share price, of the fund’s shares. When that profit is paid out to shareholders as a capital gain distribution, its NAV will be reduced by the amount of the distribution. However, this doesn’t mean that investors are losing money. Investors can either take capital gain distributions in cash or reinvest them, as most investors do. If capital gains are reinvested, the number of shares in the account will increase, leaving the total value of the account unaffected by the distribution.“[/learn_more]
Here are a few takeaways that I got from this experience (that you all can learn from:
A Mutual Fund’s NAV Decreases When Capital Gains Are Paid
Self-explanatory, just remember that even though the mutual fund looks like it just had a major loss, all of this is paid back to you in a cash distribution, and you lose no money.
Accepting The Loss And Learning From It Is Much Better Then Freaking Out
I went through these two phases in this experience. Freaking out and being upset won’t change the price. Accept the loss because it is all part of the game. Study it, and learn how you can avoid it in the future.
Learn Everything About The Asset (and Investment Vehicle) That You Are Investing In Before You Buy It
I did know that mutual funds paid out capital gains, but didn’t understand how it affected the price and how it actually worked. If I did, it would have saved me a lot of stress and anxiety.
And now, I will leave you with a quote.
“Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.” – Warren Buffet