The 411 on Distributions

Brought to you by Sound Choices - AGF Education for Investors and Advisors

Distributions are payments from a 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

1. 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.

2. ‘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.

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

All funds have different objectives and may have different distribution policies. One series of a mutual fund, for example, 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.

4. 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.

5. 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.

The best ways to maximize compound growth is to:

• Reinvest all distributions in additional units to grow your principal, rather than getting paid out in cash.
• Take advantage of tax sheltered plans such as a Registered Retirement Savings Plan (RRSP) which defers any tax on distributions as long as the funds remain registered and/or in a Tax-Free Savings Account (TFSA) where all investment income is tax-free.

Which tax reporting slips are provided in order to report distributions paid?

Funds or portfolios

If the trust funds or portfolios paid a distribution in 2023, a “consolidated” T3/RL-16 slip:

• Will be mailed (usually with the annual statement, aggregating the reporting of distributions from funds or portfolios.)
• Would be issued unless the income consists solely of “other income” (usually interest) and is less than $1.

Classes

Corporate class mutual funds are “classes” of a mutual fund corporation. A corporate class structure does not distribute interest or foreign income to its investors and is able to offset any income or gains earned within the corporate class structure against expenses from anywhere within the mutual fund corporation.

If the classes invested in paid a dividend and/or a distribution in 2023, a “consolidated” T5/RL-3 slip:

• Will be mailed (usually with the annual statement, aggregating the reporting of the dividends and/or distributions from the classes in each account).
• Would be issued unless the dividend and/or distribution per account in the year was less than $1 (refer to the annual statement).

What about ETFs? Are they taxed like mutual funds or like securities?

If an ETF is set up like a mutual fund trust, it would pass through both income and capital gains earned within the fund to unitholders in the form it was received by the fund – for example, income earned is passed through as income. ETFs generally pay capital gains at year-end in the year they are earned and pay income in the first few weeks following year-end. As with mutual funds, this is only applicable to investors holding ETFs in non-registered accounts.

To better understand your investment, please contact your financial advisor. Don’t have a financial advisor? Before you start your search, read about working with a financial advisor.