How Dividends Affect Net Asset Value?

Many mutual fund investors wonder whether they should choose products that pay or re-invest dividends and what impact distribution payments have on the fund’s Net Asset Value (NAV). Generally, the NAV of a fund is expected to drop following a dividend payment, but that is not a reflection of the investor crystalizing a financial loss. Asset classes such as equities and bonds can offer dividend or interest payments to investors and these are then translated on a portfolio level within the fund. The fund manager then has the obligation to distribute them to the shareholders of the fund.

Key Learning Points

  • Funds that invest in traditional securities such as stocks and bond receive dividends or interest/coupon payments from their underlying holdings that they have to distribute to the fund’s investors.
  • The Net Asset Value of the Fund is expected to decline following a distribution payment, but however this is not a financial loss and the decline should mirror the level of payouts.
  • Investors can also choose to invest in the accumulation version of a product, where dividends are re-invested automatically and do not reach the end investor in the form of cash.
  • Whether interested in accumulation or distribution version of a mutual fund, investors should also consider the total return they achieve on their investment.

NAV and Distributions

The Net Asset Value of a fund is basically the value of the total assets (total value of the underlying securities, including cash and cash equivalents) divided by the total number of outstanding shares/units. It is usually calculated once a day for mutual funds and can either purchase or redeem their shares at this price.

Net Asset Value = Total Assets / Total Number of Shares Outstanding

Typically, investors have two options when investing in a mutual fund. The Income version of a product offers its shareholders the distribution of dividends in the form of cash on a specific date after they become available. The other option is Accumulation which automatically re-invests the proceeds from holding companies into the fund.

For that reason, investors in the distribution (or income) share class of a fund should expect the NAV to decline after the payout of dividends, but only to the level of that payment. This is not a consequence of a poorly performing stocks within the strategy. In fact, while there is a large number of investors that prefer to re-invest the dividend proceeds, distribution is preferred by investors who would like to receive additional income from their investments to support their lifestyle or help them work towards a specific goal that requires regular cash. As an example, this type of strategy may fit the needs of retired investors who would like to receive regular cash payments.

The Concept of Total Return

Total Return is a performance measurement that considers not only the capital gains, but dividend distributions as well. It is also considered as a measure of the real return achieved on an investment expressed as a percentage, as it shows the broader picture and the actual value added by distributions in addition to capital appreciation.