Mutual funds are part of many investors' portfolios. Offering a way to access professionally managed investments with low minimum investment amounts. Whether you're looking for company cash protection or want to invest that latest round for growth.
What Is a Mutual Fund?
A mutual fund is a financial vehicle that pools money from many investors to buy a diversified portfolio of securities.
Investing in and buying shares of a fund makes you a partial owner of all the fund's holdings. This immediate diversification is a shortcut from the investor doing it themselves.
Management of a mutual fund is led by investment companies. They handle the day-to-day operations, portfolio management, and administrative functions. The combined holdings of these securities make up the fund's portfolio. Each investor's shares represent a part of these holdings proportional to their investment.
Mutual funds are widely popular with investors. This popularity stems from the funds' ability to provide professional management and diversification with low minimum investment requirements, making them attractive options for both individual investors and corporations.
How Mutual Funds Work
Investing in a mutual fund is like outsourcing professional money managers on your behalf. These managers research opportunities, select securities, and track performance according to the fund's objectives. Fund objectives include a focus on liquidity, steady income, or growth.
You can buy mutual fund shares directly from the fund or through investment professionals like Rho Treasury. The price you pay for mutual fund shares is set by the fund's net asset value (NAV), which represents the per-share market value.
Understanding NAV Calculation
The NAV calculation determines exactly what you pay when buying mutual fund shares. Unlike stocks, mutual funds price once daily based on their net asset value (NAV), calculated at the end of each trading day using closing market prices.
NAV calculation formula:
NAV = (Total value of all cash and securities - liabilities) ÷ Outstanding shares
NAV calculation example:
If a mutual fund holds $45 million in securities and $5 million in cash, its total assets amount to $50 million. After accounting for $10 million in liabilities, the fund's net asset value (NAV) is $40 million. With 4 million shares outstanding, the NAV per share would be $10.
Types of Mutual Funds
Understanding mutual fund types is key to building a strong treasury strategy. While many options exist, most investors rely on four core categories that align with cash flow needs and timelines.
- Money market funds with lower risk that invest in high-quality, short-term investments
- Bond funds that invest in various types of bonds
- Stock funds that invest in corporate stocks
- Target-date funds are designed to adjust risk profile over time
Funds may be passively managed, like index funds that track a market index, or actively managed by a fund manager aiming to outperform the market.
How Mutual Fund Distributions Are Determined
Mutual funds must distribute virtually all of their income and capital gains to shareholders to avoid paying corporate taxes on these earnings. When determining distributions, fund managers consider several factors.
Sources of Distributions
A mutual fund may earn income from various sources:
- Interest and dividend income from securities it holds
- Capital gains from selling securities at a profit
- Foreign income from international investments
These earnings can be offset by expenses, and capital gains can be offset by capital losses. The net amounts remaining after these offsets are sent to shareholders as a distribution. When a mutual fund sells securities that have increased in value and there are no offsetting capital losses, the resulting gains are also distributed to investors.
Not all funds make distributions. If a fund's objective only permits investing in growth companies, those companies do not pay a dividend, so the fund may not make income distributions. However, capital gains distributions can still occur if the fund sells appreciated securities.
How and When Distributions Are Paid Out
Mutual fund distributions follow a structured process with specific timing and payment methods.
Timing of Distributions
Mutual funds distribute income and capital gains on schedules varying by the fund. Below are examples that are most common:
- Income distributions (dividends and interest) may occur monthly, quarterly, or semi-annually
- Capital gains distributions usually happen once annually, typically in December.
Fund companies publish their distribution calendars in advance, allowing investors to plan.
Distribution Process
When a fund makes a distribution, it sets a "record date" to determine which shareholders will receive the distribution. The record date is the cutoff date establishing which shareholders are on the books as owners, making them eligible to receive the upcoming distribution.
The "ex-dividend date" is most often set as the record date. Or one business day before if the record date is not a business day. Purchasing shares on or after the ex-dividend date makes you ineligible for the next distribution. You will be up for the following.
Distribution allocation is proportionate to the number of units held on the record date. For example, you hold 100 mutual fund units on the record date. And the distribution was $0.50 per unit. You would receive a distribution of $50.
Payment Methods
Mutual fund distributions are typically paid out in one of two ways:
- Cash Payment: The fund sends a check or deposits the amount into your designated account.
- Reinvestment: The distribution immediately goes to buy more shares of the fund.
It's important to note that when a distribution is made, the fund’s NAV decreases by the amount of the distribution per share.
For example, if a fund has a NAV of $10 and pays a $0.25 distribution, the NAV will drop to $9.75 after the distribution.
How Reinvesting Distributions Compounds Returns
The Power of Compounding
Reinvesting dividends involves using the cash distributions paid by a fund to buy more shares of the same investment. This strategy leverages compounding, a way both the initial investment and the reinvested distributions generate future returns. Over time, this cycle leads to accelerated portfolio growth. Distribution reinvestment puts your earnings to work to generate more future earnings. The process creates a magical cycle:
- Your initial investment earns distributions
- Reinvested distributions buy more shares
- Your larger share balance earns more distributions
- The cycle repeats with the goal of accelerating your returns
Practical Example of Reinvestment
The investor owns 1,000 shares priced at $20 per share., Paying an annual dividend of $1 per share. The dividend payment of $1,000 reinvests, buying 50 more shares.
The following year, dividends were calculated on 1,050 shares, increasing the total payout to the investor. This reinvestment strategy increases returns, especially when combined with share price appreciation.
If an investor reinvests distributions for more shares/units, the market value of their fund will remain the same pre- and post-distribution (not accounting for market fluctuations). This is different from taking the distribution in cash, which reduces the invested amount and potential for future growth.
At Rho, we want to help clients maximize their investment returns. So, reinvestment of distribution is the default setting when using Rho Treasury. Don't worry, though. You can also choose to receive those payments in cash.
Tax Consequences for Mutual Fund Investors
While considering the tax implications for your mutual fund investments. Please reach out to your CPA or accounting team for confirmation. The information below is only for informational purposes.
Taxable Events
Mutual fund investors may face tax obligations even without selling shares:
- Capital gains distributions: When a fund sells securities at a profit and distributes those gains to shareholders. You must pay taxes on your part of these gains, even if you reinvest them into the fund.
- Dividend and interest distributions: Income generated by the fund's investments and distributed to shareholders is generally taxable in the year received.
- Capital gains from selling fund shares: When you sell your mutual fund shares for more than you paid for them. The profit is taxable as a capital gain.
You may face a tax bill even if your fund had a negative return for the year. This can occur when the fund’s realized gains cannot fully offset its losses.
The Power of Mutual Funds
Mutual funds are one of the most accessible and effective investment vehicles. They provide investors with low investment minimums, access to professional management, and instant diversification.
Whether you're investing for liquidity, income, or growth, mutual funds may help you meet your goals. Reinvesting distributions provides a powerful flywheel for compounding returns over time. While quality tax guidance can help optimize after-tax returns.
As with any investment, you should research the fund and its prospectus and consider consulting with financial advisors.
Rho is a fintech company, not a bank or an FDIC-insured depository institution. Checking account and card services provided by Webster Bank N.A., member FDIC. Savings account services provided by American Deposit Management Co. and its partner banks. International and foreign currency payments services are provided by Wise US Inc. FDIC deposit insurance coverage is available only to protect you against the failure of an FDIC-insured bank that holds your deposits and subject to FDIC limitations and requirements. It does not protect you against the failure of Rho or other third party. Products and services offered through the Rho platform are subject to approval.
Investment management and advisory services provided by RBB Treasury LLC dba Rho Treasury, an SEC-registered investment adviser and subsidiary of Rho. Rho Treasury investments are not deposits or other obligations of Webster Bank N.A., or American Deposit Management Co.’s partner banks, are not FDIC insured, are not guaranteed and may lose value. Investment products involve risk, including the possible loss of the principal invested, and past performance does not future results. Treasury and custodial services provided through Apex Clearing Corp. and Interactive Brokers LLC, registered broker dealers and members FINRA/SIPC.
This content is for informational purposes only. It doesn't necessarily reflect the views of Rho and should not be construed as legal, tax, benefits, financial, accounting, or other advice. If you need specific advice for your business, please consult with an expert, as rules and regulations change regularly.
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