The dividends and interest earned by a mutual fund on its investment is the fund’s dividend (income). Balanced and Equity Income funds usually distribute dividends to shareholders quarterly, i.e. March, June, September and December. When a fund sells an investment security for a higher price than originally paid, the fund has a capital gain. A capital loss is realized when the fund sells an investment security for a lower price than originally paid. If the investment security is held by the fund for more than one year, the gain or loss will be a long-term capital gain or loss. When the investment security is held by the fund for less than one year, the gain or loss will be a short-term capital gain or loss. Gains and losses are netted together and when the fund has a net gain, that gain is usually distributed to the share holder once a year (November or December).
By law, mutual funds income and realized capital gains must be paid out to shareholders. These distributions are taken from the portfolio assets which is why the net asset value is reduced by the same amount as the distribution. Example: A distribution value of $0.15 will be given all shareholders on November 15. The net asset value on market close of November 15 will be reduced by $0.15 plus or minus that day’s performance.
Shareholders can either purchase more shares to increase the number of shares owned by reinvestment or they can receive full payment in the amount of the shares owned distribution value.
The net asset value (NAV) of a mutual fund is the same as the share price because they do not trade on the open market. The fund company determines a share price by dividing the total current market value of all the cash and securities in the fund’s portfolio, minus any liabilities, by the number of outstanding shares. In addition, the mutual fund’s share price is further reduced by the amount of distribution to shareholders.
The daily net asset value changes are known as the performance of the mutual fund. The percentage of performance is a gain or loss when the fund’s net asset value is more of less than the value of the share price. The return of a mutual fund includes the distribution and the performance. An NAV computation is undertaken once at the end of each trading day based on the closing market prices of the portfolio’s securities.
Here is a “hypothetical” Dividend Distribution/Reinvestment model of an Equity Income fund
Initial Purchase: $2,500 1/4/2010
Net Asset Value/Share Price: $20.00
Maximum sales fees: 5.00%
Investment Value: $2,375.00 (-5.00%)
Shares purchased: 118.75
3/31/2010 Distribution of income $0.10 per share
Net Asset Value: $21.00
Total value of distribution: $11.875
Additional shares gained/reinvested: 0.5654
Total shares owned: 119.3154
Total Performance: $21.00 – $20.00 divided $20.00 = 5.0%
Total Return: $21.00 + $0.10 – $20.00 divided $20.00 = 5.5%
Yield on Investment: $21.00 x 119.3154 = $2,505.62 – $2,500 = 0.22%
6/28/2010 Distribution of income $0.09 per share
Net Asset Value: $20.75
Total value of distribution: $10.738
Additional shares gained and reinvested: 0.5174
Total shares owned: 119.8328
Total Performance: $20.75 – $20.00/$20.00 = 3.75%
Total Return: $20.75 + $0.09 + $0.10 -$20.00/$20.00 = 4.70%
Yield on Investment: $20.75 x 119.8328 = $2,486.53 -0.56%
9/30/2010 Distribution of income $0.10 per share
Net Asset Value: $22.00
Total value of distribution $11.983
Additional shares gained and reinvested: 0.5446
Total shares owned: 120.3774
Total Performance: $22.00 – $20.00/$20.00 = 10.0%
Total Return: $22.00 + $0.10 + $0.09 + $0.10 – $20.00/$20.00 = 11.45%
Yield on Investment: $22.00 x 120.3774 = $2,648.30 5.93%
12/31/2010 Distribution of income $2.00 per share
Net Asset Value: $21.00
Total value of distribution $240.75
Additional shares gained and reinvested: 11.4645
Total shares owned: 131.8419
Total Performance: $21.00 – $20.00/$20.00 = 5.0%
Total Return: $21.00 + $0.10 + $0.09 + $0.10 + $2.00 – $20.00/$20.00 = 16.45%
Yield on Investment: $21.00 x 131.8419 = $2,768.68 10.74%
Using this scenario (12/31/2010 $2.00 distribution) is when a investor should strike while the mutual fund distribution is hot! The reason being, the share price is $2.00 lower than the previous opening market day value. Assuming the opening net asset value was $23.00, the closing purchase price is $21.00 -8.69%.
Search the internet for: “mutual funds that distribute income and/or capital gains” to find these type of funds.