Do mutual funds pay interest?
How Do Mutual Funds Distribute Income?
Mutual fund distribute income to shareholders throughcapital gains distributions or dividend distributions. Interest earned by a
fund's assets is paid as a dividend distribution. To avoid paying taxes on
earnings, mutual funds are required to pass on all net income to shareholders
at least once each year. However, if the assets in the fund's portfolio pay
interest more frequently, such as monthly or quarterly, the fund is likely to
make dividend distributions that match the payment schedule of its assets.
Bond funds, as the name implies, invest in corporate orgovernment-issued debt. While not all bonds pay interest annually, the vast
majority do; the interest paid by a bond fund is a direct result of the couponpayments generated by the bonds in its portfolio. Unless the fund includes
zero-coupon bonds, each security in the portfolio pays a set amount of interest
each year, called its coupon rate, which is then passed on to shareholders
according to their investments in the fund.
Money Market Funds
Money market funds also invest in corporate or government
debt but only in very short-term issuances that mature in less than a year.
These types of mutual funds are generally considered the most stable type of
fund, because they invest primarily in government bills and notes or very
highly rated corporate debt with maturity dates less than three months down the
road. Like bonds, these types of debt securities pay annual interest that is
passed on to shareholders as dividend distributions.
Interest-Bearing Balanced Fund
A balanced fund is simply a mutual fund that includes both
debt securities and equity securities. These funds generally make dividend
distributions comprised of interest from both debt assets and dividend payments
from investments in the stock market. Like bond and money market funds,
balanced funds generally pay some interest each year. However, if one of the
goals of the fund is to minimize shareholders' tax liabilities, the fund
manager may choose to avoid interest-bearing debt or dividend-paying stocks altogether.
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