v* Dividends. Some stocks pay dividends. Most companies make profits and pay out some of these profits to shareholders in the form of dividends. Some high-growth companies reinvest most or all of their profits right back into the business. As a mutual fund investor, you can choose to receive your fund's dividends as cash or reinvest them by purchasing more shares in the mutual fund.
Unless you need the income to live on (if, for example, you're retired), reinvest your dividends into buying more shares in the fund. If you do this outside of a retirement account, keep a record of those reinvestments because those additional purchases should be factored into the tax calculations you'll make when you sell the shares. (Find the lowdown on the relationship between fund investments and taxes in Chapter 13.)
u* Capital gains distributions. When a fund manager sells stocks for more than he or she paid for them, the resulting profits, known as capital gains, must be netted against losses and paid out to the fund's shareholders. As with dividends, your capital gains distributions can be reinvested back into the fund.
Appreciation. The fund manager isn't going to sell all the stocks that have gone up in value. Thus, the price per share of the fund should increase (unless the fund manager made poor picks or the market as a whole is doing poorly) to reflect the gains in unsold stocks. For you, these profits are on paper until you sell the fund and lock them in. Of course, if a fund's stocks decline in value, the share price will depreciate.
If you add together dividends, capital gains distributions, and appreciation, you arrive at the total return of a fund. Stocks (and the funds that invest in them) differ in the proportions that make up their total returns, particularly with respect to dividends. Utility companies, for example, tend to pay out more of their profits as dividends. But don't buy funds that concentrate on utility stocks thinking that you'll make more money because of the heftier dividends. Utilities and other companies paying high dividends tend not to appreciate as much over time because they aren't reinvesting as much in their businesses and growing.
Was this article helpful?