There are thousands of funds types in the market and dozens of strategies to suit every investor’s choice. Index funds, actively-managed funds, lifecycle funds/target date funds, lifestyle funds, balanced funds, tax-managed funds etc. your choice of mutual fund depends on the purpose of your investment- whether it is to save taxes or to build wealth. If you are aiming at having a stable and periodic income then you can invest in a dividend paying mutual fund. You can invest in a fund that makes very few annual distributions without any dividend payments if you aim at minimizing the short-term tax impact of your investment, and are focused on long-term growth. Go for high-yield bond or equity funds if you are a risk taker and your only intention of investing is to create wealth quickly.

Although mutual funds come with a lot of market risk, they are a good way for investors to build wealth if the right mutual fund is chosen and attention is paid to the fees involved, turnover rate, investment holdings and performance of the invested fund. Further, experienced investors think long-term by diversifying the holdings and avoid the mistakes of chasing past performances, not paying attention to the tax implications and not being aware of overlapping or redundant investments. These mutual funds pay dividends to investors based on the performance of the stocks in the market. The dividend payments can be opted to be paid either as monthly, quarterly or annual pay-outs or re-invested depending on the investor’s income requirements. A mutual fund pays dividends after expenses. On an average, a 2% dividend is paid by large-cap stock on the investments in the U.S. If you are a high-risk taker whose goal is to generate more income, then you can invest in high yield mutual funds which pay high dividends. And there are yet some other high-paying funds which pay-out capital gains rather than dividends.

If you are an investor looking to take full advantage of your tax-sheltered retirement accounts like 401(k)s and IRAs, the type of account that will hold the mutual fund matters a lot. If you hold a taxable brokerage account, then tax-managed funds, exchange-traded funds, index funds, and municipal bond funds can be good tax-efficient investments for you. In addition to this, you can also invest in stocks if you have plans to hold it for a longer period (at least one year). If you hold a regular brokerage account that is subjected to taxes, then it is advisable for you to stay away from mutual funds as these funds generate hefty tax bills from capital gains distributions or dividends. Any investments made in real estate trusts (REIT funds), actively-managed stock funds, high-yield mutual bond funds and corporate bond funds are such investments that are better off within your 401(k)s or IRAs. This also includes those stocks which you plan on trading frequently. High yield mutual funds are the portfolios that generate the highest income and they primarily invest in securities of the U.S. high-income debt. Here, at least 65% or more of bond assets are either not rated or are poorly rated by the major agencies like Standard & Poor’s or Moody’s (Generally level of BB or below which is considered speculative for taxable bonds).

Things to consider while investing in high-yield mutual funds:

• Check your local laws to know if it allows any exemption on taxes: There are certain laws depending on your place of residence which may allow dividend income to be tax-free adding to your benefits.
• They are vulnerable to economic and credit risk: Since high-yield mutual funds rely mostly on bonds from companies that hold portfolios of a lower quality, they are riskier compared to bonds of higher-quality companies.
• Choose the stock type depending on your risk tolerance: You should avoid these mutual funds if you have a low-risk tolerance, as these funds invest either in highly volatile securities or employ aggressive investing strategies as they are aimed at beating the market.
• Check where the company’s dividend payments are coming from: There are two possible ways the companies may pay you the regular dividends. One could be that the company is taking out money from its working capital. The second possibility is that the higher returns may have been generated by reinvesting the dividend money in its own business and thereby appreciating the company’s stock prices. These things may also affect the benefits of compounding of the dividend amount.
• Consider the company’s consistency in making profits: The ability of the company to pay regular dividends comes from its consistent profit-making strategy. The company must also be able to have good earnings quality. If a company returns cash to shareholders, it is an indication that it is less likely to pursue big mergers or acquisitions. This usually turns out to be better for the company that was supposed to be acquired than the company that did not acquire. Having said this, since companies that offer high yield mutual funds come under the benefiting categories, these funds with low fees tend to outperform all other fund types along with generating more income over long periods of time.