The 411 on Distributions

by Sound Choices, AGF Management Ltd.

Providing a better understanding of your investments

The content in the article below is meant for Canadian investors only.

Distributions are payments from a mutual fund to the investor and can derive from multiple sources, such as income and capital gains realized from securities held within the underlying funds, as well as return of capital.

Components of a distribution may consist of:

• Dividends – Income earned on Canadian and foreign equities.
• Interest – Income derived primarily from fixed-income products such as bonds, GICs and cash equivalents.
• Realized Capital Gains – The gain received when an investment is sold at a higher price than purchased at.
• Return of Capital – Occurs when a mutual fund “returns” a portion of the money you invested in the fund, typically resulting from the fund paying a higher amount of distribution compared to the net income and gains earned by the fund.

What you need to know

Distributions do not create wealth

Wealth gets created when a fund receives dividends and interest from the underlying holdings, and through realized capital gains when holdings are sold at a profit. A distribution, when reinvested, creates units without changing the total value of the investment.

Here is an example to illustrate how it works:

When the fund declares a distribution of $0.10 per unit and reinvests it, there are two results:

1. The unit price drops by the amount of the distribution paid ($0.10) presuming the market is steady.
2. The number of units owned increases when the value of the distribution is used to buy additional units of the fund at the post-distribution price ($100 distribution buys 10 units of the fund at $9.90/unit).

Although you now own additional units of the fund, the distribution does not affect the total dollar value of the investment as you own more units valued at a lower price.

‘Distributions’ and ‘Dividends’ are not the same

A fund distribution can be comprised of dividends, earned interest, realized net capital gains and return of capital.

Dividends are only a component of distribution; they can be earned by a fund holding Canadian or foreign companies paying a dividend per share.

The higher the distribution amount does not mean the better the fund

All mutual funds have different objectives and may have different distribution policies. One series of the fund may target a 3% payout while another series of the same fund may target a 5% payout, despite holding the same investments.

If a fund cannot cover its target distribution from earned income (interest, dividends and realized capital gains), it will return capital to the investor, depleting the principal available to grow.

Distributions are not an indicator of a fund’s performance

Distribution is often misconstrued as positive performance of a fund. However, a distribution may include a combination of earnings and/or return of capital. The portion of the distribution relating to earnings only represents a part of the fund’s total return.

Overall appreciation in market value is a better indication of how well a fund is performing.

Distributions can either be reinvested in additional units of the fund or paid out as cash

Deciding which is best for you will be determined by account type and preference for income or to maximize growth.

• If you hold an investment outside of a tax-sheltered plan – outside of a Registered Retirement Savings Plan (RRSP), a Registered Retirement Income Fund (RRIF), a Registered Education Savings Plan (RESP), or a Tax Free Savings Account (TFSA) – you are required to report on your Canadian income tax return all distributions (interest, dividends or capital gains) paid to you by any fund, including those reinvested.
• On the other hand, distributions on funds held in a tax-sheltered plan do not need to be reported as taxable income as they are automatically reinvested in registered plans. Taxes are reported and owed only when money is taken out of the registered plan (the exception being a TFSA).

To find out how to get the most out of distributions, please contact your financial advisor. Don’t have a financial advisor? Before you start your search, read about finding the right advisor for you.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed; their values change frequently and past performance may not be repeated.

The commentaries contained herein are provided as a general source of information and should not be considered personal investment or tax advice. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change investment decisions arising from the use or reliance on the information contained here.

The contents of this Web site are provided for informational and educational purposes, and are not intended to provide specific individual advice including, without limitation, investment, financial, legal, accounting or tax. Please consult with your own professional advisor on your particular circumstances.

AGF Management Limited (“AGF”), a Canadian reporting issuer, is an independent firm composed of wholly owned globally diverse asset management firms. AGF’s investment management subsidiaries include AGF Investments Inc. (“AGFI”), AGF Investments America Inc. (“AGFA”), Highstreet Asset Management Inc. (“Highstreet”), AGF Investments LLC (formerly FFCM LLC) (“AGFUS”), AGF International Advisors Company Limited (“AGFIA”), AGF Asset Management (Asia) Limited (“AGF AM Asia”), Doherty & Associates Ltd. (“Doherty”) and Cypress Capital Management Ltd. (“CCM”). AGFI, Highstreet, Doherty and Cypress are registered as portfolio managers across various Canadian securities commissions, in addition to other Canadian registrations. AGFA and AGFUS are U.S. registered investment advisers. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. AGF AM Asia is registered as a portfolio manager in Singapore. AGF investment management subsidiaries manage a variety of mandates composed of equity, fixed income and balanced assets.

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About AGF Management Limited

Founded in 1957, AGF Management Limited (AGF) is an independent and globally diverse asset management firm. AGF brings a disciplined approach to delivering excellence in investment management through its fundamental, quantitative, alternative and high-net-worth businesses focused on providing an exceptional client experience. AGF’s suite of investment solutions extends globally to a wide range of clients, from financial advisors and individual investors to institutional investors including pension plans, corporate plans, sovereign wealth funds and endowments and foundations.

For further information, please visit AGF.com.

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This post was first published at the AGF Perspectives Blog.