Dividends distributed by mutual funds leave you with two options: withdraw that money and use it wherever you want or reinvest in the same scheme. The withdrawal option is rarely opted by investors as choosing reinvestment makes more sense. But, reinvesting the dividend money reduces the net asset value of mutual fund units.
Does that refer to losing money?
Technically, no. Let's understand how.
When a mutual fund distributes dividends, it pays out a portion of its earnings to its investors. It reduces the mutual fund's net asset value (NAV) because the fund's assets have been reduced by the amount of the dividend payment.
Let's understand with the help of an example.
To understand this, it's helpful to know how NAV is calculated. The NAV of a mutual fund is the total value of all the fund's assets minus its liabilities, divided by the number of outstanding shares. When a mutual fund pays out a dividend, it reduces the total value of the assets held by the fund, which in turn, reduces the NAV.
For example, let's say a mutual fund has a NAV of ₹10,000 per share, and it declares a dividend of ₹50 per share. If you own 100 shares of the mutual fund, you will receive a dividend payment of ₹5,000. However, the NAV of the fund will also be reduced by ₹50 per share, or a total of ₹5,000, because the fund has paid out this amount to its investors.
It's important to note that while a dividend distribution reduces the NAV of a mutual fund, it doesn't necessarily affect the overall value of the investment. For example, if a mutual fund's NAV is reduced by ₹50 per share due to dividend distribution, but the value of the underlying assets held by the fund increases by ₹50 per share during the same period, the overall value of the investment would remain unchanged.
But, is low NAV equal to poor mutual fund performance?
The NAV of a mutual fund represents the value of the fund's assets minus its liabilities, divided by the number of outstanding shares. A low NAV simply means that the value of the fund's assets is relatively low compared to the number of shares outstanding.
While there can be a correlation between a mutual fund's NAV and its performance, it is not always the case that a low NAV indicates poor performance. In fact, a fund's NAV can fluctuate due to a variety of factors, including market conditions, changes in the fund's portfolio, and expenses associated with managing the fund.
It is important to consider various factors when evaluating a mutual fund's performance, including its historical returns, expense ratios, investment strategy, and overall management. A low NAV alone is not necessarily an indicator of poor performance.
Now, we know that dividend distribution reduces the NAV of mutual funds units, but it does not necessarily indicate poor performance or reduce the value of your investment. Although, the higher units of mutual fund you hold, the more dividends you receive in the future during the horizon of investments.
Understanding your risk appetite and investment objective is important to make an informed investment decision and choose the more suitable mutual fund scheme.
Anushka Trivedi is a freelance financial content writer. She can be reached at anushkatrivedi.com