As we've already noted, mutual funds must pass along to their shareholders any realized capital gains that are not offset by realized losses by the end of their accounting year. Mutual fund managers "realize" a capital gain whenever they sell a security for more money than they paid for it. Conversely, they realize a loss when they sell a security for less than the purchase price. If gains outweigh losses, the managers must distribute the difference to fund shareholders.

Fund managers must also distribute any income that their securities generate. Bond funds typically pay out yields, but so do some stock funds if the stocks they own pay dividends.

As you may recall, when paying out capital gains or income, funds multiply the number of shares you own by the per-share distribution amount. You'll receive a check in the mail for the total amount of the distribution. Or, if you choose to reinvest all distributions, the fund will instead use the money to buy more shares of the fund for you. After the distribution is made, the fund's NAV will drop by the same amount as the distribution. Fund companies often make capital-gains distributions in December, but they can happen any time during the year.

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