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For example, Vanguard Dividend funds have a lot of stocks that give out dividends. Are there any regulatory requirements for Vanguard to distribute the fund? Can they decide to do whatever they want with it?

I am mainly concerned about US based securities.

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Almost all US stock mutual funds pay out the dividends received over the year in a lump sum annually, or in some cases, semi-annually or quarterly. Bond mutual funds (and money market funds) usually pay out the interest payments from the bonds or promissory notes that they hold each month, and these payments are also called dividends (and reported as dividends on the investor's US tax returns). There is usually a provision for those who choose to reinvest such dividends back into the mutual fund: the mutual fund issues more mutual fund shares to the investor who chooses the re-investment option, and in the case of load funds, the mutual fund might not charge the load on the re-investment (but will definitely charge the load if you take the dividend in cash and send it back the next day as a new investment).

In the US, all dividends (and capital gains) that are not distributed to the investor are income to the mutual fund and the fund must pay income tax on this income, whereas it is the investor who pays income tax on the distributed amounts, even if the investor chose to reinvest the money back into the fund. Thus, most mutual funds choose to distribute all the dividends and capital gains to their investors; doing otherwise is less beneficial to the fund (and to the investors too, though in view of the recent tax law changes that slashed corporate tax rates, this might no longer be true).

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    This answer only addresses practices and taxes in the US, and the question did not restrict itself to the US. It mentions Vanguard, but Vanguard operates in more than twenty different countries. – Mike Scott Aug 23 '18 at 13:46
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    @MikeScott Instead of complaining about the incompleteness of my answer, you should vote to close the question as too broad since an answer that describes the rules for "more than twenty different countries" will be far too lengthy (and not worth anyone's time to write). – Dilip Sarwate Aug 23 '18 at 14:01
  • No need to close the question; I have edited my own answer to be universally applicable. – Mike Scott Aug 23 '18 at 14:03
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It depends if they’re income funds or capital appreciation funds. Income funds distribute the dividends to their investors — that’s how they provide an income. Capital appreciation funds use the dividends to buy more shares and so increase the value of their investors’ investments. In some countries, for tax reasons, all funds may in practice be only one of these alternatives, since the other option would be more heavily taxed.

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    Not true. Even capital appreciation funds generally distribute the dividends (can capital gains from the mutual fund buying and selling investments) to their investors. – Dilip Sarwate Aug 22 '18 at 14:27
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    @DilipSarwate Perhaps mutual funds that you've invested in are different from the ones I have. But I've invested in dozens of funds over the years, and all but one automatically reinvested dividends. Only one even asked me if I wanted them reinvested versus paid out. – Jay Aug 23 '18 at 13:20
  • @DilipSarwate From the prospectus for Vanguard’s UK funds: “Holders of Income Shares are entitled to be paid the distributable income attributed to such Shares on any relevant interim and annual allocation dates. Holders of Accumulation Shares are not entitled to be paid the income attributed to such Accumulation Shares, but that income is automatically transferred to (and retained as part of) the capital assets of the relevant Fund on the relevant interim and/or annual accounting dates. This is reflected in the price of an Accumulation Share.” – Mike Scott Aug 23 '18 at 13:51
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    @Jay I too have invested in dozens of (US) funds over the years, and in all cases, I had the option of choosing whether I wanted to have dividends and capital gains paid out or reinvested. In all these instances, the default option (for those who did not make a choice) was reinvest, that is, the reinvest box was already checked when the page opened, but the investor could choose payout as the option if the investor wished to. Beginning investors often do not choose, perhaps because they don't understand the difference and trust the company to do right by them. – Dilip Sarwate Aug 23 '18 at 14:10
  • @DilipSarwate Ah, I think I misunderstood what you said before. I don't doubt that the option might be available and I was set up with the default and never knew there was another choice, or maybe I saw the option and chose not to take it and I've forgotten. But I thought you were saying that dividends are NEVER reinvested, as opposed to the account holder having a choice. Perhaps what you meant was that this is always (or at least usually) an option. – Jay Aug 23 '18 at 17:36
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Almost all mutual funds that I have ever invested in reinvest all dividends back in the funds. That is, they use any dividends to buy more stock. In effect, dividends, just like growth in value of the underlying stock, increases the value of the customer's shares in the funds.

One mutual fund that I had deposited dividends to a cash account (in my name) where I could withdraw them or reinvest them or whatever I wanted. But that turned out to be an option, and I talked to the bank and they switched to reinvesting them.

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  • In the US, reinvesting a dividend into the same fund does not cause the "value" of the customer's shares in the fund to increase, if by "value" you mean NAV (Net Asset Value per share) of the shares that the investor holds. Instead, what happens is that the fund issues more shares at a reduced price to the investor. The NAV of the mutual fund shares drops when a dividend is paid out, and for those choosing to reinvest, they get more shares at this reduced NAV. Assuming no market fluctuations, the investor ends up with more shares at a reduced NAV and the total value of the investment.... – Dilip Sarwate Aug 23 '18 at 18:39
  • .... remains the same! See this answer for some details on how all this works. – Dilip Sarwate Aug 23 '18 at 18:46
  • @DilipSarwate Well, this is true if you assume that the total capitalization of all companies is a constant, that if a company never paid dividends that the price of its stock would never change, and that paying $1 per share in dividends always and inevitably permanently reduces the value of the stock by $1 per share. But that's not how stocks work in real life. Yes, the value of a stock the day after a dividend is paid tends to be less than the value the day before a dividend is paid by approximately the amount of the dividend. But that's supply and demand: ... – Jay Aug 23 '18 at 21:27
  • ... If you buy stock the day before a dividend is paid, you're buying that share PLUS the dividend you'll get the next day. But if you buy it the day after, then the seller collected the dividend. But companies that pay healthy dividends tend to see their stock prices rise in the long haul, and of course stock prices are not constant in the absence of dividends. In any case, from the point of view of the OP's question, none of this is relevant. The point is that the investment company does not keep dividends, they don't disappear, etc. They go back to the investor. – Jay Aug 23 '18 at 21:31

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