Why Did My Mutual Fund Share Price Drop?

by Michael on Dec 20, 2012 · 0 comments

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Every year around this time, investors scratch their heads and wonder why the share price (or net asset value; NAV) of their mutual fund dropped even though the market went up.

The short answer is that many mutual funds distribute their dividends as well as capital gains around this time.

When this happens, the share price drops in proportion to the payout — though you don’t realize a loss as you receive a cash payment equivalent to the decrease in share value. In other words: not a big deal.

From a tax efficiency perspective, however, this is a bummer. After all, it generates taxable income. But it is what it is — and it’s required by law. The good news is that most index funds are fairly tax efficient and have little in the way of realized gains.

But still, the combination of a quarterly dividend payment plus a year’s worth of capital gains liabilities (from buying and selling that occurs within the fund) is often enough to produce a noticeable blip in share price.

The good news (if you want to call it that) is that some mutual funds are still carrying enough embedded losses from 2007-2009 that they can fully offset their capital gains liabilities. But that’s not always the case.

This sort of thing has given rise to advice that you should avoid investing shortly before the end of the year to avoid “buying the dividend” — i.e., buying shares just before they generate taxable income. Then again…

If you delay your purchase in a rising market, it’s likely that your hesitation will cost you more in appreciation than you save in taxes.


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