Generally speaking, dividend-seeking investors are those near or in retirement who want monthly income from their investments to supplement Social Security and pension income. However, some pre-retirement investors look for income from mutual funds to build their fund balances faster. As dividends are paid, these investors reinvest the income to buy more shares.
Money Market Funds
Money market mutual funds pay monthly dividends regardless of what's happening in the stock market. These funds invest in U.S. government bonds, U.S. corporate bonds, certificates of deposit and other forms of debt. The yield on money market funds generally is the lowest yield of all mutual funds, but these are considered safe and stable funds.
U.S. Bond Funds
Bond funds that invest in U.S. Treasuries, corporate bonds, mortgage-backed securities, municipal bonds and other debt securities pay monthly dividends, usually at a higher rate of return than money market mutual funds. When you purchase individual bonds, you always know what your monthly yield will be, but this is not true when you buy shares in a bond fund. Throughout the year fund managers buy and sell bonds in their portfolios and interest rates change, so the return from a bond fund fluctuates from month to month.
International Bond Funds
Another class of bond fund, called the international, foreign or global bond fund, also pays monthly dividends. These funds might hold some U.S. bonds in their portfolios, but they focus primarily on foreign government debt, such as bonds issued by European and Asian countries. If you already have a U.S. bond fund, an international bond fund can add global bond exposure along with its monthly dividend payments. However, international bond funds are subject to greater interest rate fluctuations and can be riskier than U.S. bond funds, according to Motley Fool.
When dividend-paying mutual funds are held in taxable accounts, income must be reported for Internal Revenue Service purposes. When these funds are held in tax-deferred accounts, dividend income that is reinvested in the fund does not have to be reported at tax time.