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There is an ETF/fund I was looking at and I noticed a curious mix of what goes into their regular "dividend" payout. The amount consists of dividend income + long/short capital gains, and Return of Capital. It's the last that I was unfamiliar with, especially as how it is used as part of distribution mix. I've read the Investopedia entry on the term and so understand, technically, what it is, but I don't really understand the implication on an investment/position when some of the distribution is from, or based on RoC. Can anyone explain it simply?

Here is what my financial site displays (March and May are where the distribution is a combo of dividend and RofC):

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Return of capital is a (generally) non-taxable distribution of original principal. ROC is often part of fund/ETF distributions when there's a goal of a steady income stream. In your example, there appears to be a distribution target of $0.1821/share/mo.

ROC should reduce your adjusted cost basis (you can only have capital returned to the extent of your contributed capital), which means that eventually your cost basis could fall to $0. At that point, ROC becomes a capital gain distribution.

The main benefit of this is tax deferral. Instead of paying tax on your entire distribution today, the ROC portion reduces your basis and you'll eventually pay taxes on that gain when you sell or your basis is reduced to $0.

Maybe this fund distributed capital for tax benefits of shareholders, maybe it was because there were insufficient gains or dividends to distribute in March and April to fully cover the distribution target, or it could've been a combination of the two.

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  • "...maybe it was because there were insufficient gains or dividends to distribute in March and April to fully cover the distribution target" Yes...this is what I was thinking...the fund clearly pays out the exact same amount month after month, i.e. their "target". My curiosity in the matter is whether cannibalizing principal (is this a fair characterization?) to hit a target amount on a "no matter what" basis is a sign of any sort of financial weakness.
    – AA040371
    Jun 26, 2023 at 18:46
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    @mblatz01 it could be bad, but might not be. I agree that cannibalizing principal is generally bad if sustained because it means the investment is slowly winding itself down. Unless you want to invest in something that has a set term, probably not desired. On the other hand, if it's temporary, it's not necessarily a bad thing. A bad year might force ROC distributions until the investment starts generating sufficient returns again. The key to me here is evaluating the long-term sustainability of the distribution.
    – Stan H
    Jun 26, 2023 at 20:44
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    @StanH: If you don't want it to wind down you can reinvest the ROC amount when you get it. It is less convenient than if they didn't pay the ROC but your total basis will stay the same. Your basis/share will reduce and you will have more shares. Jun 27, 2023 at 2:19

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