Why the Net Assets Value (NAV) of Mutual Fund Units Falls After Dividend?

Actual Question:

Why does MF NAV drop after paying dividend?

I assume dividend paid by MF is the dividend paid by stock-companies.

Answer:

Dear Friend!

Your question has two parts as follows:

1. Why the NAV drops after paying Dividend?
2. Is the dividend paid by the mutual fund is the same as paid by the companies in whose stocks the mutual fund invested the money.

Let's examine them one by one.

Why NAV of Mutual Funds Falls after paying Dividends:

Till the time the dividend is paid the value of the dividend gets accumulated and reflected in the NAV and once the dividend is paid out, naturally the NAV comes down. Please see the example below:

In the case of stocks also the same things happen. The price of the share falls after the record date fixed for dividends. Then people popularly term the phenomenon as the stock has become ex-dividend.

Is the dividend paid by the mutual fund is the same as paid by the companies?

Under normal circumstance this should be the case, which is the prudent, conservative and correct policy. However, it is not uncommon for mutual funds to pay more dividends than actually earned, by dipping into the capital sum invested. This is obviously to please/ impress the investors that the fund had earned and paid handsome dividend, when it is not actually the case. Please see the following example:

In conclusion, when dividend is paid, cash accompanied by value is lost and therefore the NAV of the mutual fund unit drops. Many a time funds pay dividends out of capital which is very objectionable practice.

Thank you,

With Best Regards

Anand

"More Crop You Invest..." - Poem on Investing and Returns

Today I chanced upon reading a very short yet an elegant poem “More Crop You Invest..”  by Ignatius Hosiana. He was talking investments and returns using crop and farming as metaphors.

The message conveyed is that the more you invest, the more dividends you reap, which triggers many crucial questions; how can manage to invest more? What are good investment habits? 

Let me describe the simple good investment habits that will take you to great heights:

1. Invest First and Spend Next: when you receive your pay-check, first invest the planned amount and thereafter go about spending, again as per the budget.
2. Control the Urge to Splurge: Lead a simple lifestyle. This will leave additional cash in your hands that will let you invest more. Additionally, by doing so, you will be setting a very valuable example to your children.
3. Develop Patience: The poet was conveying the message in the language of crop and farming. Farming requires enormous patience - so does investing. Once you have invested well, after thorough prior research, simply forget the investments. Leaving investments untouched will assist the law of 'Miracle of Compounding' to labor for you and produce significant returns on investments.
4. Slay the Inner Demons:  Greed and Fear the worst internal ghosts that an investor needs to exorcise. Success in investing does not require genius; it only requires character.

Lets enjoy the poem "More Crop You Invest..", discover the true message conveyed by the poet and reap the handsome dividends on investments.

Investors Shall Learn to Slay the Demons, 'Greed' and 'Fear'