The SEC’s Office of Investor Education and Assistance (OIEA) is issuing this Investor Bulletin to explain fund distributions and how they can impact investors.
What are fund distributions?
Fund distributions are payments an investment fund makes to its shareholders. These payments are one way shareholders of a mutual fund, exchange-traded fund (ETF), closed-end fund, or other type of investment fund might make money from their investment. Not all funds pay distributions.
Some funds plan to make distributions to shareholders on a regular basis, such as monthly or quarterly. Regular distributions can help provide shareholders with predictable cash flow. However, distributions are not guaranteed. It is also possible to lose money in a fund that pays distributions.
Shareholders might have the option to reinvest distributions automatically. In that case, the fund does not send cash to the shareholder. Instead, the fund uses the cash to buy more shares of the fund for the shareholder. Reinvesting distributions can help grow a shareholder’s investment over time.
Funds pay distributions to shareholders in proportion to the amount of shares they own.
Where can I find information about a specific fund’s distributions?
An SEC-regulated fund must explain its distribution policy in its prospectus. SEC-regulated funds include mutual funds, ETFs, and closed-end funds like business development companies (BDCs) and interval funds.
You can obtain a prospectus from the SEC’s Electronic Data Gathering, Analysis, and Retrieval (EDGAR) database or directly from the fund. Most funds make their prospectuses available on their websites and have toll free numbers for requesting a copy, free of charge.
In addition, many fund websites post distribution schedules (but distributions are not guaranteed).
How do funds pay for distributions?
A fund pays for distributions out of money the fund makes and/or with return of capital.
A fund might make money from, for example, dividends, interest, or capital gains. Dividends are payments from equity securities the fund owns. Interest is money earned from fixed income securities the fund owns. Capital gains are money the fund makes (or realizes) from selling securities that increased in value.
Return of capital is when the fund uses shareholder principal, or the money shareholders paid to buy fund shares, to pay for all or part of a distribution. In other words, the fund gives shareholders back their own money. A fund might issue a return of capital if the fund’s income is not enough to pay for a promised distribution.
When an SEC-regulated fund issues a return of capital, it must send you a written notice called a 19(a) notice. You can often find 19(a) notices on fund websites.
How do distributions affect my investment value?
When a fund distributes dividends, interest, or capital gains to shareholders, the fund’s net asset value (NAV) decreases. For ETFs and other funds that trade on national securities exchanges, the market price of fund shares also typically decreases. But these decreases do not mean you lost money. Rather, they reflect a transfer of value (cash or new shares) to you.
When a fund distributes a return of capital, it reduces the fund’s asset base, or the money available for the fund to invest. A smaller asset base could make it harder for the fund to make money in the future or could raise its operating costs. Thus, returns of capital can limit the growth of or cause a loss on your remaining investment.
Exercise caution with a fund that consistently uses return of capital. Frequent or regular returns of capital could be a sign the fund is making higher distributions than it can afford.
Some funds promote high distribution rates that may look appealing. It is important to understand where those distributions come from. Keep in mind:
A fund’s distributions are not the same as performance.
A fund can perform poorly and still make distributions.
Do not rely solely on a fund’s distributions to understand fund performance. More reliable indicators of fund performance include total return and standardized yield (also called SEC yield). If an SEC-regulated fund reports total return and/or SEC yield, you may find those figures in the fund prospectus and typically on the fund website.
What are the tax consequences of distributions?
When you hold fund shares in a taxable account (such as a brokerage account), you might have to pay taxes on distributions from the fund’s capital gains, interest income and dividend income. This can be true even if you reinvest your distributions.
Return of capital is not taxable when you receive it, but it can increase your taxable capital gains when you sell your fund shares. This is because a return of capital decreases the principal in your investment, or basis.
Consult a tax professional for more information about the taxation of fund distributions.
Additional Resources:
Using EDGAR to Research Investments | Investor.gov
This Investor Bulletin represents the views of the staff of the Office of Investor Education and Assistance. It is not a rule, regulation, or statement of the Securities and Exchange Commission (“Commission”). The Commission has neither approved nor disapproved its content. This Bulletin, like all staff guidance, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person.
