A:

Some mutual funds pay interest, though it depends on the types of assets held in the funds' portfolios. Specifically, bond funds, money market funds and balanced funds pay interest because of the coupon-bearing debt securities in which those types of funds invest.

How Do Mutual Funds Distribute Income?

Mutual funds distribute income to shareholders through capital gains distributions or dividend distributions. Interest earned by a fund's assets is paid as a dividend distribution.

To avoid paying taxes on earnings, mutual funds are required to pass on all net income to shareholders at least once each year. However, if the assets in the fund's portfolio pay interest more frequently, such as monthly or quarterly, the fund is likely to make dividend distributions that match the payment schedule of its assets.

Types of Mutual Funds That Pay Interest

Bond Funds

Bond funds, as the name implies, invest in corporate or government-issued debt. While not all bonds pay interest annually, the vast majority of them do. 

The interest paid by a bond fund is a direct result of the coupon payments generated by the bonds in its portfolio. Unless the fund includes zero-coupon bonds, each security in the portfolio pays a set amount of interest each year, called its coupon rate, which is then passed on to shareholders according to their investments in the fund.

Money Market Funds

Money market funds also invest in corporate or government debt, but only in very short-term issuances that mature in less than a year. These types of mutual funds are generally considered the most stable type of fund, since they invest primarily in government bills and notes or very highly-rated corporate debt with maturity dates under three months.

Like bonds, these types of debt securities pay annual interest that is passed on to shareholders as dividend distributions.

Interest-Bearing Balanced Fund

A balanced fund is simply a mutual fund that includes both debt securities and equity securities. These funds generally make dividend distributions comprised of interest from both debt assets and dividend payments from investments in the stock market.

Like bond and money market funds, balanced funds generally pay some interest each year. However, if one of the goals of the fund is to minimize shareholders' tax liabilities, the fund manager may choose to avoid interest-bearing debt or dividend-paying stocks altogether.

RELATED FAQS
  1. How often do mutual funds pay capital gains?

    Find out how often mutual funds distribute capital gains income, including the basics of how mutual funds work and why frequent ... Read Answer >>
Related Articles
  1. Financial Advisor

    How mutual funds pay dividends: An overview

    The process by which mutual fund dividends are calculated, distributed and reported is fairly straightforward in most cases. Here's a look.
  2. Investing

    How Tax-Efficient Is Your Mutual Fund?

    Learn about factors that influence the tax-efficiency of your mutual fund, how income from your investment is taxed and what to look for when choosing a fund.
  3. Financial Advisor

    Income tax on mutual funds: The basics

    Learn about the basics of income tax on mutual funds, including what types of income may be subject to the capital gains tax rate.
  4. Investing

    How to sell mutual funds to your clients

    Learn about the top talking points to cover when discussing mutual funds with clients – and how explaining their benefits can help you close the sale.
  5. Investing

    Meet Your Investment Objectives With Income Funds

    Discover the categories of income funds and the types of investors for whom they are appropriate.
  6. Investing

    Looking to Buy Mutual Funds Online? Here Is How

    Learn how to buy mutual funds online; discover which websites offer mutual fund trading services, how to choose a fund and typical fees.
  7. Investing

    How Interest Rates Affect Mutual Funds

    Find out how changing interest rates impact mutual funds, including bond and money market funds, and how higher rates can discourage investors.
  8. Financial Advisor

    Top 5 American Funds for Retirement Diversification in 2016

    Discover five mutual funds from industry leader American Funds with high yields that are perfect for retirement savings diversification.
RELATED TERMS
  1. Mutual Fund

    Mutual funds combine money from many investors to invest in a ...
  2. Distribution

    Distribution occurs when a mutual fund, company or retirement ...
  3. IRS Publication 564: Mutual Fund Distributions

    IRS Publication 564: Mutual Fund Distributions is a publication ...
  4. Capital Gains Distribution

    Capital gains distribution occurs when a mutual fund manager ...
  5. Pooled Funds

    Pooled funds aggregate capital from a number of investors, as ...
  6. Fund

    A fund is a source of money that is allocated for a specific ...
Trading Center