Why does the Mutual Fund NAV price go down when dividends are paid out?

We’re often asked, “Why does the share price of the mutual fund go down when dividends are distributed?” Here’s our answer.

The NAV is the Net Asset Value of a mutual fund – that is, it is the total value of the assets within the mutual fund. It is a value that adjusted daily based the way stocks in the fund’s portfolio fluctuate. It might even help to think of the NAV as a “meta” stock ticker: it captures an overall picture of all the holdings of a mutual fund and is adjusted daily. Because of market changes, your NAV today is likely to be different from your NAV tomorrow.

Finding the NAV

A shortcut to finding the NAV that’s usually accurate is to assume it’s the price per share; this is usually, but not always, correct. The NAV is recalculated every day based on changes in securities that are held in the mutual fund; in contrast, stocks change prices by the second based on market demand.

To calculate, you simply take the current market value of all securities held by the fund minus any liabilities, and then divide this number by the number of outstanding shares. This is Net Assets / Outstanding Shares.

What the NAV Is Good For

Unlike standard stocks, a number like NAV that seems to reflect the value of a fund in the market doesn’t work quite the same way for mutual funds. Legally, mutual funds must distribute at least 90% of realized capital gains and dividend income annually, and when a mutual fund pays out this cash, its NAV will drop by the same amount.

This is something that frightens investors that don’t realize it’s coming, and they may sell off the mutual fund without investigating further.

But that’s not what’s happening. A sudden drop in apparent value because the NAV has dropped does not mean the investor has lost money; rather, that value has been paid out to the shareholder. To maintain portfolio value, you simply have to make sure the dividends are reinvested back into your fund.

In general, you can expect your NAV to change every day, but it does not change every minute. The NAV is not a good way to assess how your mutual fund is doing; instead, you should track the overall annual returns of your funds. As long as you are reinvesting your dividends, you can do this by simply calculating the growth of the overall value of your fund. In the end, that’s what matters after all, isn’t it? Instead of tracking the direction of the NAV, you get a much better performance assessment by simply tracking how well your fund is growing. This gives you a better handle on performance.

What Should I Look At Instead of the NAV?

First, read the prospectus and the annual reports of the mutual fund. These will give you a good idea of earnings and growth for that fund, and how robust it is.

Second, remember that the NAV is affected by two things: the payout and the fact that many mutual funds are always open to new shareholders – which means more shares may be sold, which changes the divisor in the NAV calculation.

Since this makes NAV less than reliable, start looking inside the fund. Look at the larger stock holdings, and take a look at their P/E, P/C, ROE and other metrics. Learn a little about what they mean. Though most people buy mutual funds as a shortcut, so they don’t have to worry about these numbers, when you first buy one knowing that your mutual fund buys only the best stocks reassures you that you’re picking up a mutual fund that’s good for the long term.