A:

Mutual funds split the same way individual stocks split, but less often. Like stock splits, mutual fund splits do not result in any change in net value, so they are primarily a marketing device.

What Is a Split?

A split occurs when a mutual fund increases the number of shares outstanding while simultaneously decreasing the price per share by the same factor. The price of a mutual fund share is called its net asset value (NAV) per share and represents the total value of the fund's portfolio, minus any liabilities, divided by the number of shares outstanding.

Splits are much more common in individual stocks than in mutual funds, with the most common splits being 2:1 or 3:1. In a 2:1 split, the number of shares outstanding is doubled, while the price per share is halved. A 3:1 split triples the number of shares and reduces the share price to one-third of its original value. (For related reading, see "Is Investing in Stock Splits Profitable?")

Example

When a mutual fund splits its shares, the total value of any given shareholder's investment does not change. While the price for new shareholders is reduced, so is the ownership stake each share represents.

Assume you own 100 shares of a mutual fund with a current NAV per share of $500. The fund announces a 2:1 split, meaning you now own 200 shares with a NAV per share of $2.50 instead of 100 shares worth $5.00 each.

Why Do Mutual Funds Split?

As with stock splits, the main goal of declaring a split is to make the mutual fund more attractive to individual investors. However, since any future gains generated by the fund are not affected, the effect of a share split is entirely psychological.

When share prices get too high, many investors think they are priced out of the market. If a fund splits its shares, investors think the fund is now within their price range and are encouraged to invest. The truth is, however, an investment in a mutual fund has the same value whether it is made before or after a split.

In the above example, a $10,000 investment before the split would have purchased 2000 shares. After the split, that same investment would have purchased 4000 shares. In either case, the value of the investment is still $10,000.

(For related reading, see "What Is a Split-Adjusted Share Price?")

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