Q: Why do mutual funds' net asset values fall after they pay out dividends?
A: Many mutual fund owners have been writing me in despair. These investors are bemoaning the fact that the share price or net asset value (NAV) of their mutual funds have been falling lately by large amounts.
There are two reasons for this. First, stock prices have been falling since the end of 2007. A fund's NAV is equal to the closing prices of all the stocks it owns plus any cash held by the fund. If share prices of the stocks held by the fund fall, as they have been, then the NAV of the mutual fund falls, too.
This year, through Friday, the Standard & Poor's 500 index has fallen 9.75%.
But there's another reason for falling NAVs. Remember, a mutual fund's NAV is equal to the value of the stocks it owns plus cash. At the end of the year, mutual funds are required to distribute any cash dividends they receive and any capital gains to shareholders. When the funds make these distributions, that reduces the amount of cash they hold. That, in turn, reduces the NAV of the fund, and the share price, by the size of the distributions.