To understand the advantages that can be gained by purchasing dividend paying mutual funds, it may be helpful to understand exactly what the name means. A mutual fund is a collection of bonds, stocks, and money markets that is professionally managed. Investors join a pool of other investors and purchase units in the fund. The amount of the fund’s profit (or loss) is apportioned based on the amount of each investor’s position. Because investors deal with the fund, shares are easy to buy or sell.
Dividends are payments made by a company or a fund to its shareholders. They indicate that the company has made a profit. Typically, paying dividends is a sign that a company’s financial position is solid. Struggling companies either do not have the cash or need all their cash to keep the doors open. The payment of dividends can make the company’s stock more attractive to new investors and keep current investors pleased with performance.
Mutual funds typically pay dividends quarterly. How the dividends are taxed depends on the type of fund. For example, real estate investment trusts and bond funds do not generate qualified dividends in the eyes of the Internal Revenue Service. Stocks and most utilities, on the other hand, receive better treatment for taxes as long as a minimum of sixty days has elapsed between purchase and the date shareholders qualify for a dividend.
Mutual funds offer a convenient method of tapping into a dividend stream. There is no need for the investor to try to identify individual stocks. Most funds are comprised of dozens or even hundreds of stocks, so the investor is instantly diversified. With many stocks in the fund, the risk is minimized, since no one company can have a major impact on the investment. In addition, since purchasing mutual funds does not generate a commission for the broker, it is possible to make small investments at frequent intervals without generating large fees. All of these factors make mutual funds a safer and more economical method of investing than choosing individual stocks.
When purchasing dividend paying mutual funds, investors should look for an established fund with a successful record of accomplishment. A good income fund will feature high-yield stocks as well as a diversified portfolio that offers the potential for dividend growth. Funds must state the scheme and goals under which they operate, so reading the prospectus carefully and educating oneself on investments in general are advisable.
Investors should realize that higher yield stocks often carry a greater risk. Choosing a well-diversified fund minimizes the risk of loss. Since there are so many funds from which to choose, investors should select one that has a portfolio with which the investor is comfortable. Making a mutual fund that pays dividends part of an investor’s portfolio can be an excellent option. However, investors should remember the mantra of diversification, and make sure that their portfolios include other investment options as well.