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So there are a lot of fixed-income funds, and the ones focusing on non-investment grade corporate bonds seem to produce a lot of interest (around 7~8% each year). Now my question is almost all of them have the disclaimer that dividends may be paid out of the capital. This sounds horrific.

Is there a way for me, as an investor, to know exactly how much is paid out of the capital? Because I am assuming that this statement means if I invested $10,000 at for example a Net Asset Value of 20, collecting a very nice 7~8% interest, and when in the future the NAV rises to 23 and I opt to sell my holdings, I might not actually get $11500 because "dividends may be paid out of the capital". I'll get less money back. Maybe even less than the $10,000 I initially put in.

So in the extreme does this mean the fund literally takes 7~8% out of my own money and give it to me less fees? How is this amount exactly quantified? Otherwise this sounds like a horrible scam.

Thanks for the help!

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  • How could anyone doubt 'dividends' being paid out of the capital was horrific? How is that even possible, without distorting both general and financial English? How am I wrong to think that 'dividends' necessarily come from earnings; profits? How am I wrong to think that a payment out of capital might be something like a disbursement but it can't be a 'dividend'? Feb 21 at 22:44

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I think you're overreacting. Most if not all of the "dividends" will come from the coupons that the bonds they hold pay, but there may be cases when the dividends come from the capital earned by buying/selling bonds. The coupons also might change as they buy/sell bonds with different coupons. There might also be times when, if market yields go up, the value of the bonds goes down, even if the coupons are constant. So depending on the activity within the fund, they might need to dip into capital to continue paying the dividend that investors expect. Obviously the intent it to replace that capital through growth and profits from buying/selling bonds. It would take very extreme circumstances for them to take ALL of the dividends from capital - it would normally just be a small portion. It should also be outlined in the quarterly report of the fund, outlining what income was received from bond coupons, what income was received from transactions, and you could compare that to the dividend that was paid out.

I would also note that dividends from "fixed income" funds are NOT guaranteed, and neither is the NAV. They can fluctuate with market yields just like stock funds can withe overall market performance.

It's not a "scam" - you just have to know the risks involved (which are much less than the risks for stock funds)

if I invested $10,000 at for example a Net Asset Value of 20, collecting a very nice 7~8% interest, and when in the future the NAV rises to 23 and I opt to sell my holdings, I might not actually get $11500

No - if you invested $10,000 in 500 units at $20 per unit and it rises to $23, you still have 500 units and would get $11,500. "paid from capital" does not mean that they take units away from you. IT just means that the source of that dividend was not entirely from coupons.

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Its likely that this mutual fund wrote these rule so they will not be limited to always pay out of dividends/interest only. The amount paid out by capital will vary from payment to payment so it is unknowable if you are looking to know this for future payments. The company is unwilling to commit to saying x amount of the payout will be from capital.

And my question to you, is does it really matter? Provided payments are constant and not in jeopardy does it matter the value of the asset?

Two examples:
You purchase a long term Bond A that pays 4.5%, you are happy with this rate. Somewhere along the life of this bond it craters in value due to rising interest rates. Are you still happy? In a way you should be as you counted on the 4.5% income and are still receiving it.

Target over the last year or so has varied from 110/share to 150/share. During this time it has paid a dividend of 1.10/share. If you purchased this stock at 150, because you liked the long term prognosis of the company and the dividend, should you be upset that it craters to 110/share? I'd say not, it just doesn't matter that the market is being a bit irrational.

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I think some of the others may be a bit optimistic. If you invest $10000 in a 10 year fixed income fund at 7%, then they will pay you $700 a year. That's a fixed income.

You need to know what they are investing in, and whether the amount they guarantee to pay is believable for that investment.

If whatever they have invested in grows well in a year, then that $700 will come out of the growth. If it fails to grow, or falls in value, then that $700 will come from selling off assets held by the fund.

In the best case, at the end of the period, you will get back more than you paid in, and get to keep all the dividends.

In the worst case, you will get back much less than you paid in, because they have been draining the funds to keep paying the dividends every year.

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    The dividend of a fixed income fund is NOT fixed or guaranteed - it should be relatively stable but can change based on the coupons it receives from the fixed income securities (usually bonds) it owns and the growth in value of those securities. But it is not guaranteed. (and there is no such thing as a "10 year" fixed income fund or any fund with a fixed maturity)
    – D Stanley
    Feb 20 at 22:53
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    In other words, a "fixed income fund" is a fund that invests in fixed income securities. It is NOT a fixed income security itself.
    – D Stanley
    Feb 20 at 22:55

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