Whenever you’re looking at a mutual fund for income, you have to be aware of what the source is for the money they are paying. A mutual fund might have this really impressive 5% payout. But it might be deceptive. There are potentially three sources for those payouts. The good, the maybe ok, and the bad.
The good:
That’s the interest and dividends earned on the securities they hold. It’s what we all think of as the yield.
The maybe ok:
This is the payout of capital gains they’ve made on sales of securities. They made a nice profit on a stock, and so they are paying some of that capital gain as the distribution. That may be ok, but it’s not necessarily sustainable, particularly in a declining market.
The bad:
The bad is return of capital. They are promising to payout 5%, and to keep that up, they sell some shares and send you that money. They are just taking money out of your own pocket to keep up that generous distribution.
Mutual funds have to disclose the source of their payouts. Take a careful look, particularly at funds that have ‘managed payouts’. They are the ones more likely to send you back your own money as a distribution (the bad).