Distribution of dividends reduces the net asset value (NAV) of mutual fund shares. However, this doesn't mean that fund investors sustain a loss.

Fund Distributions

Mutual funds invest in a number of different securities, including stocks and bonds. Whenever these securities offer dividends, the fund is obligated to distributed them to shareholders. For example, bond funds purchase bonds that pay interest, which is passed on to shareholders in the form of dividends.

How Distributions Affect Net Asset Value

A mutual fund's NAV is calculated by dividing the value of the fund's assets by the number of the fund's outstanding shares. When a fund distributes dividend payments to its shareholders, the NAV declines. Shareholders must keep this in mind when attempting to determine how well their investments are performing.

A significant number of investors choose to reinvent fund distributions automatically instead of receiving them in cash. When dividend payments are reinvested, the shareholder receives either additional shares or a fraction of an additional share in place of the cash payment. The NAV still declines by the amount that is distributed, but the total value of the fund investment for the investor stays the same.

Total Return

The NAV doesn't tell the whole story of a mutual fund's performance; total return does. Total return is expressed as a percentage of the NAV over a given time period. It represents both appreciation and fund distributions. Together, these reflect the true return on investment of a mutual fund.

Advisor Insight

Russell Wayne, CFP®
Sound Asset Management Inc., Weston, CT

When a mutual fund pays a dividend, the value of each share is reduced proportionately. For example, if you were to begin with a net asset value of $20 per share and the mutual fund pays a dividend of $1 per share, the net asset value would be reduced to $19.

When you receive the dividend distribution, you could either keep the cash or reinvest it in additional shares of the mutual fund at the reduced net asset value.