Auction Preferred Shares

Beginning in February 2008, the functioning of the auction market for certain types of “auction rate securities” in the U.S. was disrupted by an imbalance between buy and sell orders. Issuers of auction rate securities included student loan programs, municipalities and closed-end funds.

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Reinvesting Closed-End Fund Distributions

Similar to some open-end mutual funds, many closed-end funds seek to pay distributions to shareholders on a quarterly, monthly or other regular schedule. For many investors, cash payouts may provide a valuable source of current income. For investors who do not need supplementary income, however, there is another alternative — to automatically reinvest their distributions by purchasing additional shares of the closed-end fund on an ongoing basis. Along with simple convenience, this approach has other potential advantages, as well as trade-offs. Closed-end fund investors should weigh all relevant factors and consult with their financial advisors before choosing to reinvest distributions.

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Return of Capital Distributions Demystified

Most closed-end funds pay regular monthly or quarterly distributions to their shareholders. Like open-end mutual funds, they are required after each year-end to provide an IRS Form 1099-DIV to every shareholder who received distributions during the year stating the distributions’ federal income tax character. Fund distributions may be characterized variously as:

  1. Dividends1
  2. Capital gain distributions or
  3. Nondividend distributions, also known as return of capital distributions.

1 Fund dividend distributions may include non-qualified ordinary dividends (taxed at ordinary income tax rates), qualified dividends (taxed at rates applicable to long-term capital gains) and exempt-interest dividends (not subject to regular federal income tax).

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