Earnings on Mutual Funds

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Earnings on Mutual Funds

Mutual funds offer more than one source of income.

Click here to get a recap of what a mutual fund is and what risks you should consider.

Things To Know

  • Dividends are paid from the earnings of the securities in the funds.
  • When a security in a fund is sold, any net gain on it must be distributed to shareholders.
  • The fund itself may experience gains in value.

Dividends

Mutual funds pay their shareholders dividends from the earnings of the stocks, bonds, and other securities in the funds. You can receive dividends as cash, or you can reinvest them into the funds. Many funds will automatically reinvest your dividends if you authorize them to. Dividends will be taxed at favorable long-term capital gains rates if they are held long enough and are derived from dividend income from stocks owned by the mutual fund. If the dividends come from a return of capital or a tax-free municipal bond fund they will be generally tax-free. If the dividends are received within a tax-favored retirement account, the tax will be deferred.

Capital gains distributions

Another source of potential income in mutual funds is capital gains distributions. When securities in a fund are sold, any net gain on it must be distributed to shareholders. You can receive your capital gains distributions as cash, or you can have them reinvested. The rates that apply to dividends also apply to capital gains distributions.

Capital gains

You may also benefit from share price increases. These are the increases in value of the shares in your fund. If the price of one share increases by one dollar, you have made a gain of one dollar times the number of shares you own. This type of gain is called paper profit because you do not receive it until you sell shares. Once you have sold the shares, you then have a capital gain.

Total returns

All of these sources of gain make up the total return of a mutual fund. Here is a hypothetical example:

Example of Total Return

How total returns are expressed

Funds usually express total returns in percentages. For example, if a fund appreciates 10 percent during a given year and it has a 6% dividend yield, then its total return will be 16%.

The concept of total return gives investors a way to determine the real value they are receiving from their mutual funds, as well as a means of comparison-shopping among funds.