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How Mututal Fund Dividends Make You Money

Your Investments Pay Dividends Which is A Major Source Of Income

In this post I want to talk about how dividends make you money when you’re invested in mutual funds. Sometimes called the yield, dividends are an income based on a specific percentage of your investment value. It varies from investment to investment.

When you invest your money in mutual funds you expect a return on your investment as long as the market is doing well. In a well-performing bull market the value of your investments are going up such that a $50 share of the mutual fund might be worth $52 a few months later. This doesn’t translate into an actual profit unless you sell it and pocket the $2 per share.

There is another way your investments can make money, by way of dividends. This is a set percentage that the mutual fund company promises you, paid either quarterly or annually. If they offer you 3% dividends annually, then you would expect $1.50 by the end of the year per $50-share.

Example Of A Bond Mutual Fund

One of the bond funds I hold at Vanguard has the following monthly distribution schedule. Though most dividends are paid out quarterly or annually, this one is paid every month.

On the far right column is the annual dividend/yield which is then divided by 12 to give you the actual $ distribution per share. Each share costs around $10 as you can see in the second to last column and so I would get about 2 cents per share per month.

If I searched for this fund on the Vanguard website I would come up with the following snapshot, showing the price per share and the yield (or dividend) per share, annually.

Of course, we don’t just choose a fund based on how much it will pay us in dividends, more factors should be considered. But there are those who have “dividend strategies” where these higher paying dividend funds are favored.

As an example, if I owned $100k of this bond then I would get ~$190/month in dividend income. It may not seem like much but don’t forget, dividends are just one aspect of generating income from investments, the other being selling appreciated funds, called capital gains.

Example Of My Own REIT Fund

Here is a bond I’ve owned since last year, a REIT fund, VGSLX. I have around $20k invested in it. Of course, from month to month the price fluctuates, but the dividends from the account keep coming.

Even if the balance of the account went from $20k to $15k, I would still get my ~2% annual dividends, paid quarterly in this case. The payout would be lower of course because of the drop in share price, but I would still be making an income.

In the above account summary of dividend payouts, you can see that’s approximately $500 that I made for 3 quarterly dividend earnings on my REIT investments. These are held in a ROTH IRA which means I don’t even have to pay any taxes on this dividend income.

Dividend Income From All My Investments

I am not very aggressively invested, and I’m not trying to maximize my dividend income. Those who do, called dividend investors, position their portfolio to hold the highest yielding funds, some paying as much as 5-7% per year.

According to my records, I’ve made nearly $5,000 in 2016 from the nearly $500k of investments which I hold in mutual funds. That’s about 1% in dividends which is a bit lower than expected because I have held a good amount of my money in cash and I had a lot less invested earlier in the year since I’ve been adding more and more to my investments in 2016.

What Happens To Dividends

You can choose what happens with your dividend income. Most accounts are set to automatically reinvest any income from dividends, the funds are used to buy more shares.

In your account settings you can change this, opting to have the dividends deposited into a savings account or money market account, also called a settlement fund.

Taxes On Dividends

Dividends are treated a little differently when it comes to taxation. It isn’t just considered extra income, on which you would pay ordinary income tax rates. It is often taxed lower than you income.

Not all dividends fall into this category. If the dividend is qualified then it will be taxed at a lower rate, a rate that’s set based on your income level. Most mutual funds will report how much of their dividends is qualified and how much non-qualified.

Note, we’re talking about investments held in taxable accounts, if they are held in tax-deferred retirement accounts then, of course, you wouldn’t owe any taxes on them until you reach retirement age and take contributions.

If you are in the lower-income brackets then you don’t even get taxed on your dividends, 0%. This makes sense, if you’re a retiree and aren’t making much money then it’s better for you to keep most of your dividends.

In the middle-income tax brackets you will be taxed at 15%. So if you had $10k of dividend income for the year then you’d pay $1,500 in taxes.

Once you’re big-baller status and in the highest income tax brackets, which in 2016 was somewhere in the 39% range, then you would pay 20%, which is maximum you would pay on qualified dividends.

 

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