The mutual funds have become one of the most popular investment vehicles among the new and experienced investors. One of the questions most individuals have been raising is whether the mutual funds do pay dividends. The most simplistic answer is yes, a number of mutual funds actually pay dividends but one has to understand its working before venturing into any investment.
How Do Mutual Funds Generate Dividends?
Mutual funds are securities that invest in a portfolio of diversified securities like stocks, bonds or any other monetary assets. As these underlying securities bear interest or dividends, the mutual fund receives this income. Moreover, when the fund manager sells part of securities at a profit, then it creates capital gains. This income can be used as dividends whether in form of dividends or interest or capital gains and can be passed to the investors.
The most common sources of mutual funds income is through the payment of dividends by stocks, interest rate of bonds and the realized capital gains on the sale of securities at a higher value as compared to its cost price. All this money is collected and pooled in the fund and then distributed by the fund among its investors, depending on how many shares each investor possesses.
Frequency of Dividend Payments by Mutual Funds
Investors usually have a question as to how regularly mutual funds declare dividends. It all depends on the kind of mutual fund, and the specified distribution policy. There are those mutual funds that pay monthly dividends and there are those that can pay dividends quarterly, semi-annually or even yearly.
Faster payout funds Investment funds that pay more frequently are generally income-oriented, e.g. bond funds or dividend equity funds, and paid more frequently than funds that reinvest a large part of their earnings, e.g. growth-oriented funds.
The following, whether frequent or not, mutual fund companies are obliged to publish their schedule of dividends in fund prospectus. This assists the investors in forecasting their cash flows and reinvestment plans.
Do All Mutual Funds Pay Dividends?
Mutual funds do not all pay dividends. The payment of dividend by a mutual fund varies based on the investment objective of the fund and holding of the fund. Growth-oriented mutual funds (on a capital appreciation basis), might reinvest all the income and capital gains to purchase additional securities, bringing growth in the net asset value ( NAV ) of the fund, instead of paying income. Conversely, mutual funds that are income-oriented are designed to produce periodic payouts, and will hence be likely to pay out dividends.
Investors should be very keen in aligning their investment objectives to the mutual fund they invest in. Investors who want to gain regular income may be interested in dividend-paying mutual funds, and those who want to achieve long-term growth may choose the mutual funds having their profit reinvested.
Tax Implications of Mutual Fund Dividends
Its taxation is based on the type of income that the investor receives and where he resides as all the dividends that the mutual funds pay are taxed. In the common scenario, qualified dividends are subjected to a lesser taxation rate whereas the interest and short-term gains are under ordinary income taxation. Capital gains which are long term are usually given positive tax treatment.
It is very important that investors talk to a tax expert or financial advisor to see how dividends of mutual funds will affect their general tax position. Other investors might also take advantage of tax favored investing accounts, e.g. retirement accounts, to shelter a portion of the distribution income against current taxes.
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Reinvesting Mutual Fund Dividends
Information about automatic dividend reinvestment plans (DRIPs) is available in many mutual funds, and this permits the investor to reinvest their dividends and capital gains distributions to buy the fund in more shares. Such a strategy will be effective in terms of compounding returns especially among long-term investors.
One of the effective methods that can increase the investment portfolio without adding more funds is reinvesting the dividends. But those investors who are using the dividend payments as their living expenses might like to be compensated in cash.
Conclusion
The answer to the question of whether mutual funds pay dividends is rather simple, yes, quite a lot. The details, however, vary according to the nature of the fund and its investment strategy and individual objectives of the investor. It is essential that dividends of mutual funds be understood, the frequency of payment, taxation consequences and reinvestment requisitions.
It is always advisable to read the prospectus of the mutual fund and it may be even prudent to seek the guidance of the financial experts to make sure that the mutual fund is suitable to your financial goals.
