Do I receive any economic benefit when a Mutual Fund makes a distribution?

Question

Do I receive any economic benefit when a Mutual Fund makes a distribution?

I am asking this question from the point of view of someone evaluating my income. Let’s say to evaluate how much I should pay in spousal support. By “economic benefit” I mean... Am I any wealthier or do I have more money that I can spend on bills? Please note that I am not asking this question from an income tax point of view. I understand how/why it is reported to the IRS.

For example, let’s say that I own 1000 shares of a mutual fund that has a NAV of $50/share. This is a total value of $50,000.

If the fund pays a $1/share distribution. The NAV goes to $49 and they issue me $1,000 in distributions. My net worth has stayed at $50k. I will report on my tax return $1,000 of “income” but did I really receive any economic benefit? Yes, if I did not reinvest the distributions, I do now have $1,000 more in liquid assets but I also have $1,000 less in mutual funds. All that happened is that I had a forced liquidation of some of my investments.

I am afraid that people confuse this with me selling the fund for $51 a share an earning $1,000 above my initial investment.

I do understand the argument of distributions spreading my taxable gains out over a longer period that may reduce a future tax bill. But I would argue that I would likely have more wealth in the long run by paying a larger tax bill in the future and keeping the amount I would pay now to the IRS invested for the long run.

Either way, after a distribution I don’t feel that I have any additional wealth or spendable income. I just have paper taxable income. But no additional income to spend.

Please let me know if you see some economic value that I get from a mutual fund distribution or is it just an unavoidable downside of this type of investment?

Answer 1

Either way, after a distribution I don’t feel that I have any additional wealth or spendable income. I just have paper taxable income. But no additional income to spend.

You see it as paper taxable income because you are reinvesting the funds. But you could take the $1,000 and spend it. Some people who ask about why people invest in stocks with zero dividends, do so because they want to spend the dividends.

If the investment was in a 401(k), or IRA, or similar account, you don't pay taxes on the dividend unless you pull the funds from the retirement account. But in a taxable account, the dividend is taxable because it is easy to spend.

Answer 2

I will report on my tax return $1,000 of “income” but did I really receive any economic benefit?

You did, you received cash. It's similar to selling appreciated shares - your net worth didn't change, but moving value from one asset class to another is a taxable event. This is similar to dividends (where you also don't get to choose whether to receive them). That said, some distributions are not taxable, and instead reduce your basis.

Answer 3

You are correct. There is no immediate economic benefit when a stock or a mutual fund goes ex-dividend. In fact, if received in a taxable account, it's a detriment.

However, there are other benefits. If you do not reinvest the dividend then you have lowered your cash at risk while retaining the same number of shares. If you reinvest the dividend, you now own more shares and should the security appreciate, you'll benefit from compounding.

Answer 4

Thank you everyone. You helped me answer a question that I could not find answered anywhere on the internet (maybe because the answer was obvious to everyone but me).

I never realized the share price of a mutual fund is based solely on its assets. That is why the share price is called the “net asset value” (NAV). This is unlike stock prices which are affected by demand of the shares and do not solely reflect the assets of the company.

Over the course of a year, a mutual fund may receive dividends or sell stock shares for a profit and when that event happens the NAV increases to reflect that increase in assets. At some point in the year, the mutual fund is required to distributed those gains to its shareholders.

When the shareholders get the distribution, the NAV decreases an equal amount. At the time of the distribution, the shareholders are not receiving any economic benefit BUT they had already received the economic benefit earlier in the year when the NAV had increased because the fund’s assets increased.

The distribution is just converting the gains that were already reflected by the increased NAV into a distribution to the shareholders.

This illustrates why it is usually not a good idea to buy a mutual fund in a taxable account shortly before a large distribution. Since you will be getting a tax bill for the disbursement of previous gains but you did not realize those gains because the NAV had gone up before you owned the fund.