Investing in a mutual fund allows provides a measure of protection for your savings through the use of a diversified portfolio, which you entrust to professional management. Depending on the fund's holdings, you may be due an annual payment of dividends, which you can take as a cash payment or reinvest in more shares of the fund.
When you initially invest in a mutual fund, the fund will give you the option of accepting dividends as cash or reinvesting them in more shares of the fund. At least once a year, the fund will distribute its capital gains and dividends. Some funds do this on a quarterly or monthly basis, but most distributions occur annually, and toward the end of the calendar year. You can change your selection at any time.
Cashing Out Dividends
If you accept the dividend payments as cash, you will receive a check directly from the mutual fund. The distribution of dividends is a taxable event, unless your investment is held in an individual retirement account, or IRA. If that is the case, the dividends will be automatically reinvested.
If you reinvest the the dividends, then the fund will use the money to buy more shares. Remember that this does not increase the value of your holdings, because the dividend payout reduces the share price; if $1 a share is paid in distributions, then the price of the fund will also fall by $1 a share. But reinvesting dividends does save you the trouble of taking a dividend in cash and then finding another investment for the available money. With reinvestment, your fund shares accumulate automatically.
Reinvesting is a convenient way to keep your savings growing in a mutual fund. Whether you reinvest or not, the fund will declare the distribution to the IRS and you will be subject to income tax on the dividend. You will receive a Form 1099-DIV showing the amount of the dividend, which the fund will also send to the IRS.
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