For example, Vanguard Dividend funds have a lot of stocks that give out dividends. Are there any regulatory requirements for Vanguard to distribute the fund? Can they decide to do whatever they want with it?
I am mainly concerned about US based securities.
Almost all US stock mutual funds pay out the dividends received over the year in a lump sum annually, or in some cases, semi-annually or quarterly. Bond mutual funds (and money market funds) usually pay out the interest payments from the bonds or promissory notes that they hold each month, and these payments are also called dividends (and reported as dividends on the investor's US tax returns). There is usually a provision for those who choose to reinvest such dividends back into the mutual fund: the mutual fund issues more mutual fund shares to the investor who chooses the re-investment option, and in the case of load funds, the mutual fund might not charge the load on the re-investment (but will definitely charge the load if you take the dividend in cash and send it back the next day as a new investment).
In the US, all dividends (and capital gains) that are not distributed to the investor are income to the mutual fund and the fund must pay income tax on this income, whereas it is the investor who pays income tax on the distributed amounts, even if the investor chose to reinvest the money back into the fund. Thus, most mutual funds choose to distribute all the dividends and capital gains to their investors; doing otherwise is less beneficial to the fund (and to the investors too, though in view of the recent tax law changes that slashed corporate tax rates, this might no longer be true).
It depends if they’re income funds or capital appreciation funds. Income funds distribute the dividends to their investors — that’s how they provide an income. Capital appreciation funds use the dividends to buy more shares and so increase the value of their investors’ investments. In some countries, for tax reasons, all funds may in practice be only one of these alternatives, since the other option would be more heavily taxed.
Almost all mutual funds that I have ever invested in reinvest all dividends back in the funds. That is, they use any dividends to buy more stock. In effect, dividends, just like growth in value of the underlying stock, increases the value of the customer's shares in the funds.
One mutual fund that I had deposited dividends to a cash account (in my name) where I could withdraw them or reinvest them or whatever I wanted. But that turned out to be an option, and I talked to the bank and they switched to reinvesting them.
