When is a Dividend Not a Dividend?

Back in the ’90s “monthly income” mutual funds started to become quite popular.  An example would be a balanced fund, containing dividend-paying equities, bonds, perhaps mortgages as well.  These funds would have a fixed payout, say .60c on a $10 unit price, or 6%, and pay a regular monthly distribution.  When examining many of these funds I discovered that their actual annual income produced was much less than 6% (3 or 4% for example).  The next logical question was “How do these funds pay out 6% when they only earn 4%?”  It appears that the fund company was counting on the additional income to come from capital gains or the growth of the equity component of the portfolio.  This is on top of the 2%+ annual management fee.  While not a completely unreasonable proposition, this type of fund has a major flaw, one that causes the investor to have unrealistic expectations.    Sadly these funds are, more than 20 years later, still being marketed as something they are not.  I will provide examples to illustrate the point.

I was working in the same office as a mutual fund “churner” back in the day.  He would always be looking for the next hot idea to trade funds and generate extra commission.  He sold his clients on the “safe 6%” this monthly income fund would generate.  Very easy to convince those who know little about investing.  Then along came 1994, interest rates skyrocketed in about 3 months time, and funds like this took severe losses (The good news is that this guy did did not make it to the year 2000 as an advisor).

Fast forward to 2017.  I was speaking with a couple about options for their underperforming bank mutual funds.  They were very concerned about not missing any of the “dividends” this fund supposedly paid.  I explained to them, with this fund, that the December 15th “dividend”  is not in fact extra money they would receive, but the fund paying a distribution for tax purposes only.  They were fine until he went into the bank branch and asked if he in fact missed a dividend payment.  The advisor at his bank stated that yes, in fact he had missed his dividend, and if he would have only held onto the fund it would have been paid.  He asked for the manager to confirm this, and the bank manager explained that yes, he missed out on the dividend.  These clients were now fuming at me and demanded an explanation.  With the client present, I called their client service centre, to clarify the details exactly.  The licensed representative in fact confirmed that the fund did pay this distribution, but that the unit price was lowered by an equal amount, therefore the client was no better off by receiving this “dividend”.

As an investor, you absolutely must understand that the financial system is driven by sales, and this means accumulating assets into financial products, charging fees and commissions, and retaining those assets.  After 25 years I can categorically state that these are not isolated incidents.  The word “dividend” is almost sacred to some, and mutual fund marketing departments design products to appear they are a “safe 6%” for example, which causes some to take on much more risk than they otherwise should.

Make sure you get a thorough and upfront explanation of your investment distributions prior to investing.  If you would like a simple and complete explanation of the “real” income sources in your portfolio, feel free to contact me, happy to point you in the right direction!