Mutual Funds: Investment Basics

How You Can Make Money With Mutual Funds

There are three ways you can make money from your mutual fund investment:

  • Dividend Payments — a fund may receive income in the form of dividends on the securities it owns. A fund pays its shareholders nearly all of the income it has earned, less disclosed expenses, in the form of dividends.
  • Capital Gains Distributions — The fund has a capital gain when it sells a security that has increased in price. Most funds distribute these capital gains (minus any capital losses) to investors.
  • Increased NAV — For securities the fund holds on to that have increased in price, the value of its shares (NAV) increases. The higher NAV reflects the higher market value of your investment.

For dividend payments and capital gains distributions, your mutual fund generally gives you the choice of sending you the payment, or having them reinvest in the fund to buy more shares. Reinvesting often offers the advantage of not paying an additional sales load.

Taxes & Mutual Funds

Taxes impact your investment returns so be aware of tax issues with all investments, including mutual funds. This section

gives a brief, basic overview so that you are aware of taxes.

When you own mutual funds, you will owe taxes on:

  • Distributions and dividends in the year you receive or reinvest them
  • Personal capital gains — capital gains you receive when you sell your shares at a profit
  • The fund’s capital gains on shares you buy and hold. This is unlike stocks and bonds held individually where you do not pay capital gains tax until you sell and unless you make a profit

Be sure to read the third item in the above list. It is an important difference between an investment in stocks or bonds directly versus an investment in mutual funds.

Important Note that with investments in a tax-exempt fund (such as a municipal bond fund), some or all of your dividends will be exempt from federal (and sometimes state and local) income tax. You will, however, owe taxes on any capital gains.

Hang on to all your account statements to help you figure out your taxes at the end of the year.

This section is meant to be a basic overview of taxes and mutual funds. There is more to this topic that you should learn about in order to invest wisely.