Mutual funds can realize net capital gains when they receive dividends or interest from the assets they hold and make profitable sales of portfolio assets. The fund can, in turn, return some or all of these gains to investors in the form of dividends and distributions. When a fund issues a distribution, the shareholders can either elect to be paid directly—putting the money into their account—or elect to buy more shares of the fund—known as reinvesting.
Shareholder Benefit
Whichever scenario mutual fund shareholders choose, they either benefit from $100 paid to them in cash or $100 reinvested in additional shares of the ABC Fund. If you are living off investment income, you will choose one of the dividend payout alternatives. If you are building a retirement nest egg, you will choose to plow that dividend back into more shares of the fund and enjoy the long-term benefits of compounding your investment.
For example, let's say the ABC Fund makes a quarterly income distribution of $100 as a dividend to shareholder Mary Smith. If the fund company has a money market fund, Mary could put the $100 there, which keeps it liquid and at her immediate disposal. The $100 could be sent to her by check or deposited into her bank account.
In all of these instances, Mary gets to use the dividend amount any way she pleases. As an alternative, she can elect to reinvest the $100 dividend payment in more shares of the ABC Fund. Generally, this is done through automatic dividend reinvestment instructions established by Mary and automatically executed by the fund company for her account. The dollar amount of her investment in the fund will increase by $100.
By law, mutual funds must pay out income and realized capital gains to the funds' shareholders. These distributions come from a fund's assets, which is why a fund's net asset value—and therefore its price—drops accordingly.
Though a profit from any investment is a good thing, it carries a substantial tax burden as well. Unless the income comes from a tax-free fund—like a muni bond fund—all income received from the fund must be included in shareholders' taxable income.
Advisor Insight
Russell Wayne, CFP®
Sound Asset Management Inc., Weston, CT
When a mutual fund declares a distribution, the fund price drops by a similar amount, but you aren't losing money as a result. You’ll receive the distribution in cash, which you may reinvest in additional shares of the fund.
The distribution may or may not benefit you. If the fund has been successful and the NAV is growing, that would be a good sign. But the distribution may be reflective of gains built up over time that are just now being realized. That could be cause for concern. It is more useful to focus on changes in the fund's NAV and how those changes compare to the fund's benchmark. If, for example, the fund invests in a broad range of U.S. stocks, the benchmark might be the Standard & Poor's 500 Index. If the NAV returns were better than those of the S&P, that would be good.
FAQs
Mutual funds can realize net capital gains when they receive dividends or interest from the assets they hold and make profitable sales of portfolio assets. The fund can, in turn, return some or all of these gains to investors in the form of dividends and distributions.
What is a mutual fund income distribution? ›
A mutual fund distribution represents the earnings of a fund being passed on to the individual investor or unitholder of the fund. Q: How often are distributions made? The frequency varies by the specific fund – distributions can be paid monthly, quarterly or annually.
Why do the benefits of a mutual fund help you as an investor? ›
Mutual funds give you an efficient way to diversify your portfolio, without having to select individual stocks or bonds. They cover most major asset classes and sectors.
What are the advantages and disadvantages of income mutual funds? ›
Mutual funds come with many advantages, such as advanced portfolio management, dividend reinvestment, risk reduction, convenience, and fair pricing. Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.
Why do you need a mutual fund distributor? ›
Mutual fund distributor plays a pivotal role in the world of finance, acting as the intermediary between investors and mutual funds. These financial professionals are instrumental in helping individuals navigate the diverse landscape of investment opportunities offered by mutual funds.
How does income distribution work? ›
The term “income distribution” is a statistical concept. No one person is distributing income. Rather, the income distribution arises from people's decisions about work, saving, and investment as they interact through markets and are affected by the tax system.
Do you pay taxes on mutual fund distributions? ›
If you hold shares in a taxable account, you are required to pay taxes on mutual fund distributions, whether the distributions are paid out in cash or reinvested in additional shares. The funds report distributions to shareholders on IRS Form 1099-DIV after the end of each calendar year.
What is the biggest problem with mutual funds? ›
Mutual funds provide convenient diversification and professional management through a single investment, but can have high fees, tax inefficiency, and market risk like the underlying securities.
Is mutual fund really beneficial? ›
Mutual funds may be a good investment for anyone looking for diversification in their portfolios. Learn whether mutual funds can be the right investment for you. Mutual funds offer diversification and convenience at a low cost, but whether to invest in them depends on your individual situation.
What is the main drawback of a mutual fund? ›
Potential for loss: Mutual funds are not FDIC insured and may lose principal and fluctuate in value. Cost: A mutual fund may incur sales charges either up-front or on the back end that are passed on to the investors. In addition, some mutual funds can have high management fees.
Commissions for mutual fund distribution typically range from 0.1% to 2% of the value of the purchased units. Several factors influence the commission amount, including: The asset management firm who provides the commission.
Which mutual fund distributor is best? ›
Top 10 Mutual Fund Distributors In India
- NJ IndiaInvest.
- HDFC Bank.
- State Bank of India.
- Axis Bank.
- ICICI Securities.
- Kotak Mahindra Bank.
- HSBC.
- Julius Baer Wealth Advisors (India)
Key Takeaways
A distribution generally refers to the disbursem*nt of assets from a fund, account, or individual security to an investor. Mutual fund distributions consist of net capital gains made from the profitable sale of portfolio assets, along with dividend income and interest earned by those assets.
What is the difference between a mutual fund and an income fund? ›
An income fund is a type of mutual fund or exchange-traded fund (ETF) that emphasizes current income, either on a monthly or quarterly basis, as opposed to capital gains or appreciation.
What is the source of income for a mutual fund? ›
Investors in the mutual fund may make a profit in three ways: The fund may earn interest and dividend payments from its holdings. The fund may earn capital gains from selling assets held in the fund at a profit. The fund may appreciate, meaning each fund share will grow in value over time.
