Before getting into mutual fund dividends and capital gains distributions, it helps to know how mutual funds work, their risks and how to invest in them.
Understanding mutual fund capital gains and dividends
Mutual Fund Capital Gains
Mutual funds buy and sell securities on a regular basis for their portfolio. The gains a fund makes from the buying and selling of securities by the fund manager get passed onto the shareholders of the mutual fund as a capital gain.
Any capital gains a mutual fund has made from securities in its portfolio are required to be paid out to its shareholders on an annual basis.
Capital gains can be paid out to shareholders either in cash or reinvested back into the fund.
The capital gains in non-tax-qualified accounts are taxed as ordinary income.
The Fidelity website notification sates that the amount of distribution you receive for mutual funds that do not accrue income daily is equal to the number of shares you hold on the record date multiplied by the per share distribution amount.
Mutual fund dividends
Mutual fund investors may receive recurring dividend and capital gains distributions. Dividends are never guaranteed, however, they are a form of earnings.
Companies are reluctant to reduce or eliminate the payout of dividends because the dividend payments are looked at by many investors as an indication on how healthy the company is.
Dividends are a cash payment to all shareholders of the fund(s). Actually, it is a little bit more complicated than that.
In order to keep things real simple, let me just say that if you own shares by a certain date, specified by the mutual fund, you qualify to receive the dividend payment.
By law, all mutual fund companies are required to distribute their accumulate dividends from the investments in their portfolio to their fund shareholders.
The dividend payouts to mutual fund investors must occur at least once per year. The timing and other dividend distribution details will vary from fund to fund.
Mutual funds receive dividends from stock issuers who then pass on that dividend to the shareholders of the fund.
Investors will normally receive a fixed amount per share on a regular interview, such as monthly, quarterly or annually.
Once a dividend is declared by a company they effectively become a liability to that company.
Mutual fund dividend frequency and payment amounts will vary, depending on the industry. Since the dividend payout is taken from a companies profit the payout amount can fluctuate.
The dividend that a company pays to its shareholders is often expressed as the yield or percentage relative to the stock price.
For example, a company with a stock price of $100 and an annual yield of 3.5% would pay $3.50 per share on an annual basis in dividends.
A dividend payment boosts a mutual fund profitability, even for a fund that has not appreciated in value a great deal.
When reviewing the historical returns of mutual funds be sure to check if the money paid out in the form of dividends was distributed in cash or accumulated.
If dividends are allowed to accumulate this will affect the funds growth rate.
A cash dividend can be reinvested in the same fund or into another mutual fund.
Younger, fast growing companies, such as technology companies are not likely to pay a dividend.
More conservative, lower growth industries such as utilities typically pay a higher yield dividend.
One way to supplement your retirement income is by having the mutual fund pay you the dividend in cash. The other option is to reinvest the dividend.
When you reinvest the dividend you are buying more shares of a mutual fund without paying any additional money out of pocket. Compounding is a great way to grow your account.
Dividend distributions from mutual funds are generally taxed as ordinary income unless they are in a tax deferred account.
Municipal bond fund dividends are generally free from federal income tax. They may also be free for certain state income taxes.
Dividend reinvestment plan
If you are younger you may want to reinvest the dividends back into the fund rather than take them in the form of cash. To do this simply notify your broker or mutual fund company to automatically reinvest the dividends back into the fund.
None of the contend on this blog post should be considered as tax advice. I am not an accountant. Please consult with a tax professional regarding dividends and/or capital gain distributions.
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