Equities Trade “DIRTY” – What that Means and Why it Matters

Overview: The purpose of this whitepaper is to educate readers about a flaw in our market structure, that causes income-producing securities to trade “Dirty." Dirty security pricing causes investors to pay inflated values for income-producing securities and then...

 This article will explain how the current payment system that is used to distribute dividends and interest to investors taxes the same income twice.  This inefficient process removes money from investors retirement accounts and reduces their wealth.  We also explain how FairShares can correct this problem, which results in higher returns for investors.

The dividend premium, as we have established in previous blogs, pushes the net asset value (NAV) higher, creating a capital gain.  Since investment funds accrue income to its NAV, the same dollar of income is taxed twice.  Consider the two charts below.  We have calculated the dividend premium percentage of FXAIX – an S&P 500 index fund.  This calculation can be done by computing the percent change of FXAIX anchored on an ex-dividend day and subtracting that value by the percent change of the underlying index, also calculated from the ex-dividend day.  This calculation shows how FXAIX begins trading at a premium over its index which is a result of the fund accruing dividends received to its net asset value.  The dividend premium as a percentage of the NAV can be seen in the chart titled “FXAIX Dividend Premium.”

In the chart titled “FXAIX – Dividend Premium Impact of NAV”  we inflate a share price starting at $100 by the dividend premium percentage to recreate what happens to the NAV of a traditional investment fund if there were no market movement of the underlying securities.  We are doing this to isolate the effect that accruing dividends has on the NAV so that we can show an easy to understand example.

Let us assume that Investor 1 bought the securities as noted on the chart at $100 per share.  As time passes, realized income received by the fund is accrued to the NAV, pushing it higher.  These accruals drive the NAV from $100 per share to $100.48 per share.  Then Investor 1 sells their shares to Investor 2 for $100.48 per share.

Now let’s examine the taxation of these two transactions.  Investor 1, who bought their shares for $100 and sold them for $100.48, will be taxed on their $.48 per share profit at the short-term capital gains rate (ordinary income – 50%).  Investor 2 buys the shares for $100.48, purchasing a $.48 per share dividend in the process.  Then, the day following Investor 2’s purchase, the investment fund goes ex-dividend.  Investor 2 will receive a $.48 per share dividend and will experience a drop in the NAV of the investment fund by the same amount.  Investor 2 will now owe tax on the entire dividend that they received at ordinary income tax rates (50% state and federal), even though Investor 2 owned the shares just one day.


  • The realized income that was accrued to the NAV was taxed as a capital gain for Investor 1.
  • When those same dollars that were accumulated to the NAV was paid out of the fund as a dividend payment to Investor 2, they were taxed, yet again, at ordinary income tax rates.

If we assume that these investors exchanged 10,000 shares, then we know that the total income earned by those shares was $4,800. Each of these investors paid tax on the same $4,800.  Investor 1 paid $2,400 in taxes and Investor 2 paid $2,400 in taxes, for a combined total of $4,800.  Therefore, the entire $4,800 is now gone – $4,800 in income (credit) and $4,800 paid in taxes (debit).  Poof!  The money is gone!

Therefore, the process of accruing realized income to the NAV of an investment fund causes the realized income of the fund to be taxed twice, once as a capital gain paid by the seller, and then taxed again at ordinary income rates, which were paid by the buyer who receives the dividend payment. The seller in this transaction is the only investor who should be paying taxes and they should have been subjected to qualified income tax rates, which are much lower than short-term capital gains taxes — more on that in another blog.

With FairShares, the same dollar is never taxed twice.  Our product makes the markets more fair to investors.  Please help us spread this news by sharing this article on your social media platforms.  Also, please connect with us on LinkedIn and Twitter (@BuyFairShares) so we can keep you updated on investment funds who are using our technology.


Jeremy Roseberry


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