The mutual fund is popular not only with the larger investor but with the smaller one. The average holding per investor is about $4,000, and most of the mutual fund holders have incomes of less than $10,000 per year.
There is a good deal below the surface that makes the investment in a mutual fund worth careful investigation. The mutual funds are more than opportunities to diversify stock holdings in organizations, which are expert at picking winners.
Let us start to seek out these differences by explaining the mechanism by which you finally receive the fruits of investing in mutual funds. In the first place every year each fund makes two types of payment: income and capital gain. The income comes from dividends the fund receives on stocks it holds in its portfolio. These it pays out to the fund holdersquarterly, semi-annually or annually. The fund does not pay any taxes on this income, although obviously the usual type of business corporation doesat a rate of 52 percent. This income is taxable to the individual only, the fund holder who receives it.
In 1961 these income dividends amounted to between 2 percent and 4 percent for most funds based on 1961 fund prices.
The second type of payment is the capital gain payment. If the mutual fund bought all its stocks in its portfolio in December 1960 and sold nothing in the year 1961 there would be no capital gains and no capital gains payment to any fund holder, even though the stocks appreciated in the year 1961. It pays out a capital gain only if it realizes a capital gain through the sales of a stock at a price higher than it paid for the stock when it bought itwhether in 1959 or in 1902!
Very nearly all mutual funds pay out these capital gains to the fund holders, and they are taxable to the fund holders at the 25 percent capital gains tax rate. If the fund retains these gains the fund pays the capital gains tax on behalf of the fund holder. The effect on the fund holder is the same whether the capital gain is held by the fund or paid out by the fund to the holder.
Most mutual funds send a notice to the fund holders asking them whether they want the capital gain in cash or in shares. Some of the funds urge the holders to take shares with the result that 70 percent of the fund holders do take them, and thus leave their capital gains in the mutual fund.
This choice that the mutual fund offers the fund holders is not quite what it appears to be. The letter I received in the mail from a fund in which I hold shares sounded as though the fund had really done fine this year and I could have the money and spend it. There was no distinction made between the income dividend and the capital gains dividend as far as my net worth is concerned.