The frequency with which mutual funds pay capital gains varies. However, funds that generate a profit within a given year are required to distribute gains to shareholders at least once annually.
Mutual funds are investment firms that pool the collective investment of thousands of shareholders and invest that money into a range of stocks, bonds, and other financial securities. Each shareholder is entitled to a portion of the fund's profits and may receive capital gains and dividend distributions at different times throughout the year. Mutual funds are highly liquid and highly customizable, making them a popular investment choice for many people.
Capital gains are generated when a mutual fund's manager sells an asset within the fund's portfolio for more than it cost. Much like buying a stock when prices are low and then selling on the upswing, fund managers look to liquidate holdings when they are at a premium and then distribute the gains to shareholders. Mutual funds are required to distribute nearly all profits to shareholders to avoid paying taxes on income.
Though capital gains and dividends both represent a source of investment income for the fund's shareholders, capital gains should not be confused with mutual fund dividends. While the sale of fund assets generates capital gains, dividends are paid only when a portfolio asset pays dividends or interest. The most common sources of mutual fund dividend income are dividend-paying stocks and coupon-bearing bonds.
The frequency of capital gains distributions and dividend distributions is important to investors. Though a windfall from any investment is undoubtedly a good thing, it carries with it a substantial tax burden. All income received from mutual funds must be included in shareholders' taxable income. However, gains from investments the fund holds for a year or more are taxed at the lower capital gains rate, rather than as ordinary income. Thus, a fund that buys and sells assets quickly may generate profits taxed at a higher rate. If your fund distributes capital gains often, your tax bill may suffer.