Whether you buy an open- or closed-end fund, there are three ways to make money in mutual funds:

1. Dividends and interest. Whenever an investment inside the mutual fund declares a dividend or pays interest, you receive a pro rata share of that dividend or interest.
2. Capital gains distributions. You also receive your share of any net profits from the sale of investments. These profits are called distributions of capital gains; and
3. Increased share value as the value (NAV) of the investments that are held by the fund increases or, in a closed-end fund, as the share price increases.

Dividends and distributions may be paid monthly, quarterly or annually. In the case of fixed-income mutual funds, distributions may be declared daily but only paid out monthly or quarterly.

You can choose to collect them as you go, or you can have them automatically reinvested to buy more shares. But as rabid long-term investors, we always recommend that you reinvest them. You won't miss them, and they will give your portfolio an added boost through the incredible power of compounding. The more money you put in, the more you will have when you are ready to take it out!

For tax purposes, you'll get a year-end statement from the fund showing what part of the money you've earned represents ordinary income and what part represents long-term capital gains. This distinction is important. With the advent of the long-needed tax changes in the Jobs & Growth Tax Relief Reconciliation Act of 2003, dividends and long-term capital gains are taxed at a maximum rate of 15%, while ordinary income can be taxed at up to 28% (depending on your tax bracket.) In addition, you can offset your capital gains with any capital losses you have for the year (or that you carried from previous years.)

The amount of dividends, interest or capital gain distributions you get from a mutual fund depends on the kinds of investments the fund owns. Funds invested in high-rated corporate bonds may pay you dividends of 5% - 10%, based on the income from the bonds. A fund investing in small growth companies may have little or no income from dividends. Your profit from this fund would be due to any appreciation in the stocks owned by the fund. Or a balanced fund made up of stocks and bonds may pay you a combination of dividends and appreciation.

You can read our primer on the ins and outs of different types of funds here at Dolans.com now - just click here.

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