Mutual funds generate returns in a variety of ways, including the distribution of dividends. Depending on the type of fund, dividend payments can be paid monthly, quarterly, semi-annually or annually, and the tax consequences of dividend distributions depend on the type of account that holds your mutual funds.
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Money Market and Bond Funds
Money market mutual funds, which invest in debt securities such as U.S. government and corporate bonds, pay monthly dividends. Bond mutual funds, which hold short-, intermediate- and long-term bonds or a combination of these, also pay monthly dividends. The rate of return from a bond fund typically is higher than the return from a money market fund.
Growth Funds, Value and Blend Funds
Mutual funds that invest in growth stocks tend not to pay dividends. This is due to the nature of growth stocks. When companies are in rapid growth mode, they usually hold back profits to reinvest internally and do not pay dividends. So the benefits of growth funds come in long-term capital appreciation as opposed to regular income.
Meanwhile, mutual funds that invest in value stocks usually pay dividends on a semi-annual or quarterly basis. Value stocks are issued by companies that are stable and pay dividends as part of their operation. These dividends pool within a mutual fund and are paid out to shareholders as mutual fund dividends.
Blend funds, which combine growth and value stocks, also pay dividends, usually at semi-annual or quarterly intervals.
Funds that specialize in a particular market sector, such as health care or real estate, tend to pay semi-annual or quarterly dividends as well as short- and long-term capital gains. Capital gains, which sometimes are confused with dividends, result when stocks are sold for a profit and the difference is passed to shareholders. The returns for a sector fund that pays both dividends and capital gains can be significant apart from any increase in fund share price.
When dividend-paying mutual funds are held in a tax-deferred account, such as a 401(k) or individual retirement account, dividends are reinvested so you do not have to pay income taxes on them. Conversely, when dividend-paying mutual funds are held outside a tax-deferred account, you must report those dividends as income for the current tax year.
Fund Fact Sheets
To determine whether a mutual fund pays dividends, and how often during the year, look for the mutual fund's fact sheet. You can find mutual fund fact sheets at the website of independent research firm Morningstar, or at individual mutual fund company websites. These sites will show the most recent dividend dates for individual funds, which will indicate the intervals at which dividends typically are paid.