How Does Dividends Impact Net Asset Value in Mutual Funds?

Funds that invest in securities such as bonds and stocks receive interest or coupon payments or dividends from underlying assets. The fund has to distribute these profits among its investors or can be reinvested. A dividend pay-out will certainly lower the Net Asset Value of a fund but this is not a financial loss and shouldn’t impact investment decisions.

Here’s more on how NAV gets affected by dividends.

What Is a Dividend in Mutual Fund?

Mutual fund schemes include securities in their portfolios. These securities are traded often based on a number of variables, such as price and fundamentals. The fund manager may pay dividends to unit holders when a scheme makes profits from these securities.

Do All Funds Get Dividends?

No, all funds do not get dividends. Fund managers decide on dividend payments depending on the fund's performance. While the market is down due to one or several factors such as recession, inflation, etc. the fund may choose to not pay dividends.

Equity funds provide two options – dividends or growth. Those who choose the dividend option, receive dividend payments whenever the fund declares a dividend. Otherwise, in a growth option, the dividend is reinvested and additional units are given to unit holders in place of the dividend. As a result, a unit holder will have more units even though the NAV might decline.

How Do Dividends Impact Net Asset Value?

It’s a straightforward equation that when a fund pays out its dividends, its Net Asset Value decreases. A lot of shareholders choose to have the fund’s profits automatically reinvested. As a result, shareholders get additional shares or a fraction of additional shares. So, even if the NAV decreases by paying out dividends, the gross value of the investor’s fund stays unaffected.

Does a Low NAV Reflect Poor Performance of Fund?

NAV depends on a lot of factors. Hence, a low NAV doesn’t always indicate poor fund performance. A fund manager may decide to pay out regular dividends to its investors if it is performing well. This will lower the NAV but does not indicate that the fund is not performing well.

Before investing in a mutual fund, you should consider checking more than just it’s NAV. Consider checking the performance record if you are investing in a fund that has been in the market for quite a while.

On the other hand, a fund with a lower NAV means you will receive more numbers of units rather than a fund with a higher NAV. A dividend is calculated based on the face value of the shares, and not NAV. As a result, the total dividend earned increases with the number of units held.

NAV and Distribution

Net Asset Value of a fund is essentially the value of the total assets of a fund such as total underlying securities, cash, and cash equivalents divided by the total number of outstanding shares or units. For mutual funds, it is typically calculated once a day, and investors can use it to buy or sell shares at that price.

Here is the Net Asset Value formula:

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

Investors often have two choices when investing in a mutual fund. The shareholders who choose the income version will receive cash dividends on a particular date when they become available. The alternative is accumulation, which automatically reinvests company profits back into the fund.

Dividend Reinvestment vs. Growth

As an investor, when it comes to choosing a mutual fund, you will have to make your decision wisely. Whether a dividend fund will be better or a growth fund, entirely depends on your financial objective, risk appetite, and investment horizon. Hence, before you analyse funds, make sure to figure out your criteria.

Mutual Funds with Reinvesting Opportunity

Mutual funds that offer to reinvest simply put back the profits into buying more shares rather than paying out in cash to the investors. The fund manager utilises the profit to automatically purchase additional fund units on behalf of the investors and transfer them to individual investors' accounts.

This process steadily increases the number of shares held, which causes the account value to rise more quickly than it would if profits were not reinvested. Most AMCs offer this service to the fund’s shareholders without any additional charge.

Mutual Funds with Growth Potential

The growth option of a mutual fund denotes that any dividends paid out by the mutual fund's holdings will not be received by an investor in the fund. Selecting the growth option enables the mutual fund company to reinvest the money that would have been distributed to the client as a dividend. This, instead, increases the mutual fund's Net Asset Value.

Investors who want to get regular cash distributions from their holdings should avoid choosing the growth option.

Who Are the Recipients of the Dividends?

In a dividend payout scenario, the mutual fund transfers dividends directly to the shareholders. Typically, dividends are electronically transferred into a bank account and swept right into a cash account. When dividends are paid in cash instead of through the dividend reinvestment option, shareholders often don't incur any expenses.

Final Word

There is not one perfect mutual fund for everyone. There are so many available in the market with various characteristics. This is why you should choose your mutual fund wisely so that it is able to meet your financial criteria and objectives. Net Asset Value can be one of the factors to look at, but it alone doesn’t determine the mutual fund’s health.