A friend of mine wrote to ask me why the value of his stock mutual fund is higher than the simple difference between what he paid for it a few weeks ago and the current price that he sees listed now. So I said the difference is the dividend.
He wrote back “I am so confused!” And I get that. The financial markets are confusing even to people who say they are experts. After all, if it were really all that easy everyone would be worth billions.
Especially when you’re new to investing as he is — and even for many of us who have been around for a while — things like this can feel confusing. So I created this simple explanation for my friend, and it helped him understand. Hope it helps you…
What is a stock mutual fund?
In simplest terms, a company’s stocks are investments for the people who buy them, and a way to help provide operating funds for the company that issues them. They allow you to own a small portion (shares) of the company — and in some cases they even offer dividends on your shares.
A stock mutual fund is a fund that aggregates a large number of stocks, managing the portfolio on an ongoing basis to maximize your fund’s earnings and value. The reason they hold so many stocks is to benefit from diversification, a form of risk management.
Why do these funds pay dividends?
They are passing on the earnings from individual stocks. Not all stocks pay dividends, but for some companies it’s a way to help make themselves more attractive to potential investors, helping keep the company stock in demand and (hopefully) helping to keep the stock value up higher than it might be otherwise, even in rough markets.