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Author: DeltaOne81 Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75402  
Subject: Re: Question About Index Funds? Date: 1/22/2007 12:32 PM
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First, the term you're looking for is dividend payout, or capital gain distribution, or some such. Compounding is more of a mathematical thing and not an 'action' per say.

Second, since its in an IRA, it doesn't matter.

Lets talk about something for a second. Each day the fund calculates its 'NAV' (net asset value) by adding up the value of all the things it holds. This includes cash. As it gets ready to pay out, say $1/share in cash... guess what? That means it holds $1/share in cash. Therefore, when the payout happens, the NAV drops by $1 since the fund no longer has that cash.

So, you get $1 per share in a payout, and lose $1/share in the NAV - meaning the payout itself have no actual effect. Why do it then? Taxes - its income earned for you so you need to pay taxes on it. This can't be done unless there was some transaction in your account. So they pay it out to you so you can be taxed on it as you must be by law. That's it. Since this is in an IRA, that doesn't matter to you.

The value that the fund gains is based on the growth of the companies that it holds, and the cash they receive from them, perhaps. But the cash they send out to you is due to tax law, and is neither a plus nor a minus as far as your return in concerned (in fact, in a taxable account, it would be a minus).
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