Types of Investments : Mutual Funds Part-2

- Continue from Part-1 -


But...

How does a mutual fund's NAV increase? 

Well, there are a couple of ways that a mutual fund can make money in its portfolio. (They're actually the same ways that your own portfolio of stocks, bonds, and cash can make money).

Dividends :

A mutual fund can receive dividends from the stocks that it owns. Dividends are shares of corporate profits paid to the stockholders of public companies. Although, the fund might have money in the bank that earns interest, or it might receive interest payments from bonds that it owns. These are all sources of income for the fund. Mutual funds are required to hand out (or "distribute") this income to shareholders. Usually they do this twice a year, in a move that's called an income distribution.

Capital gains :

At the end of the year, a fund makes another kind of distribution, this time from the profits they might make by selling stocks or bonds that have gone up in price. 

These profits are known as capital gains (capital appreciation), and the act of passing them out is called a capital gains distribution.

However, unfortunately; funds don't always make money. 


If the fund managers made some investments and it didn't work out, selling some investments for less than the original purchase price, the fund manager may have some capital losses.


Everyone hates to have losses, and funds are no different. The good news is that these losses are subtracted from the fund's capital gains before the money is distributed to shareholders. 


If losses exceed gains, a fund manager can even pile up these losses and use them to offset future gains in the portfolio. That means that the fund won't pass out capital gains to shareholders until the fund had at least earned more in profits than it had lost. (Although you might want to reconsider your decision to remain invested in a fund that's losing money if the rest of the market is growing).