This is the time of year when we get a lot of questions from clients about seemingly odd market movements in some of their mutual funds. Often, this “phenomenon” can be easily explained by the dividends, special dividends and/or capital gains that the funds pay.

So here’s how that works.

Mutual Funds price daily at what we call NAV (Net Asset Value). This is the price per share of the fund you own. By law, when a mutual fund’s holdings realize dividend income or capital gains, they must pay these to shareholders out of the fund’s net asset value. Accordingly, on the day a dividend or capital gain is paid, the net asset value drops by the amount that is paid.

But the story doesn’t end there.

Anyone who owns a mutual fund on what is called the “record date” is entitled to receive the dividend or capital gain. Typically, the day after the record date is called the “ex-dividend date.” It is the day that the fund’s share price reflects the fact that the dividend or gain has been subtracted from the NAV.

Then, a few (typically two) days after the ex-dividend date, the “record date” is the day that the dividend or capital gain settles in one’s account, either in the form of cash or additional shares, if the dividend or gain was reinvested.

To give an example, let’s say that mutual fund XYZ has a share price of $50 per share, and declares a quarterly dividend of $.50 per share to shareholders of record on 12/19/2013. Not factoring in any market movement on the following days (which is important to mention, because the fund’s performance will still be subject to market movement throughout this entire process), a shareholder would notice the following:

12/19/2013: Share price appears on statement as $50 per share
12/20/2013: Share price drops to $49.50 per share to reflect that the dividend has been paid out
12/24/2013: (because of weekend) Share price stays at $49.50 (again, plus or minus market movement), but the account now reflects either additional cash than was held on 12/19 OR additional shares of fund XYZ due to dividend reinvestment.

Essentially, the payment of a dividend or gain is supposed to be a “wash” in the very short term. There are many potential benefits to receiving dividends and gains in mutual funds, but those are best addressed in another blog entry.

The reason this dividend/gain process can look so skewed is illustrated by a day like yesterday, December 18. The DJIA was up almost 300 points yesterday, yet a fund that tends to track the DJIA could have shown a substantial decrease in its net asset value if yesterday was the ex-dividend date for that fund. Once the dividend or capital gain settles in the account, the performance of the fund should look a lot more “normal.”

We hope this helps to shed some light on the dividend and gain payment process. Please call us with any questions. And remember, the purpose of this entry is to explain the payment process for dividends and capital gains. It should not be construed as an investment recommendation of any kind. If you have any questions about the tax ramifications of dividends and capital gains, as always, please consult a tax advisor.

Thanks for reading, and Happy Holidays!

Carl Beck