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.
How does this affect my mutual fund?
In essence, a mutual fund is like a grocery store full of stocks, some of which pay dividends. And so, along with the actual fund price at any given time. you are also entitled to all the dividends issued by stocks that your fund owns (minus fund fees).
This makes the mutual fund an investment that pays in two ways — fund price (when the total basket of stocks go up in value) and any extra dividends, which help increase the attractiveness of the fund for some investors.
While that explanation helped my friend, I know that everyone is different. So please don’t feel frustrated if my explanation to him is still all Greek to you! 🙂
If you still want more information about mutual fund dividends or anything else about your mutual funds, please don’t be shy. This blog is here to help you. I know too many people who are so intimidated by what must seem like a foreign language, they wind up losing out in the long run.
Please feel free to leave your question in a comment on this or other posts. I’ll do my best to answer you. If I can’t, I’ll be honest with you and not try to dance around it. I started this blog to provide a safe and supportive place to help you understand your own finances.