Overhead Office

Mutual Fund Distributions and the One Day Lag in Account Values

Overhead Office

As we approach the year-end, clients should be expecting both dividend and capital gain distributions from the mutual funds in their portfolio. The mechanics may confuse some investors, so we wanted to take the opportunity to review the process.

Mutual funds are made up of individual securities such as stocks and bonds. When these individual stocks or bonds pay a dividend or coupon, it is passed through to investors. Most mutual fund companies let their investors know when payouts are expected to happen so they can plan accordingly.

When a stock pays a dividend, it can be in the form of cash or additional shares. There are two dates that are particularly important to investors: the record date and the ex-dividend date. The record date is the official date in which any shareholders must be on the record books as a shareholder of that company, and therefore will be required to receive a dividend. The ex-dividend date is usually set 2 days before the record date depending on the rules of the particular stock exchange that stock trades on. As declared by the SEC, “if you purchase a stock on its ex-dividend date or after, you will not receive the next dividend payment. If you purchase before the ex-dividend date, you will receive the dividend.”

Most IFA clients don’t necessarily worry about these particulars since there is very little buying and selling in their portfolio throughout the year unless there are deposits or withdrawals in their accounts.

What most clients do notice is the price adjustment of their mutual fund after the “ex-dividend date.” A very common question we receive is, “why did the price of this fund go down when the market was up yesterday?”

An example may help.

Let’s say that the DFA U.S. Small Cap Value fund (DFSVX) has a scheduled ex-dividend date of December 16, 2016. We are expecting a dividend of $1.00 per mutual fund share owned. On December 15, 2016, let’s say the DFA U.S. Small Cap Value opened at $37.00 and closed at $37.50. Most investors would be happy with the $0.50 per unit increase, but the next morning they wake up to find that the value of DFA U.S. Small Cap Value was only worth $36.50 per unit. Most investors may ask the question, “how did I lose money overnight when the fund gained $0.50 yesterday?” The answer is because the price was adjusted for the $1.00 dividend paid out to investors. If the distribution is reinvested, the account value will be back to normal the day after the distributions have been used to purchase new shares. 

Did investors actually lose money? Of course not! They now either own more units of DFA U.S. Small Cap Value (if they elected to have dividends reinvested) or cash equivalent (if they elected to have dividends paid to cash).

For example, if they owned 100 shares of DFA U.S. Small Cap Value on December 15, 2016, the ending market value would be $3,750 (100 shares x $37.50 per share). They also were distributed a dividend of $100 (100 shares x $1.00 dividend per share). The next morning they either own 102.74 shares of DFA U.S. Small Cap Value ($3,750 market value divided by $36.50 adjusted market price) or 100 shares of DFA U.S. Small Cap Value at a market value of $3,650 (100 shares x $36.50 adjusted market price) and $100 in cash depending on their dividend reinvestment election.

Either way, they still have $3,750 worth of market value. But even if you elected to reinvest your dividends, the value of your DFA U.S. Small Cap Value fund (and all other funds distributing capital gains or dividends that day) declined by $100.00 for a day while the custodian (Schwab, TD Ameritrade or Fidelity) is reinvesting your cash to buy more shares of the same fund. This will appear quite alarming to investors because the total value of their mutual funds decline by the total value of the distributions for a day. Since fund purchases are as of the close of the market, the reinvested distributions appear as additional shares at a lower price (adjusted down for the distribution) on the second day. 

Some investors may be wondering why there is a price adjustment in the first place. If a stock pays out a dividend to shareholders, it is usually paid from their retained earnings, which means the value of that company is legitimately $1.00 per share less than it was the day before. Investors do not lose or make money in the process: it is simply accounting. However, for taxable accounts those distributions are taxable events and so if they were avoided and companies reinvested them to create more price appreciation, it would be preferable to investors.  

The same logic can be applied to capital gains distributions. Throughout the year, fund managers (like Dimensional Fund Advisors) buy and sell securities. They earn capital gains when profits outweigh losses, which accumulate and add to the overall NAV of the fund until they are distributed. Once they are distributed, the NAV will decrease by the amount of the capital gains distributed. Similar to dividends, investors do not lose any money in the process, but they will be taxed on the distributions in taxable accounts.

If you have further questions regarding dividends and capital gains distributions and their effect on the price of a fund or value of your whole portfolio (less the cash), please contact your IFA Wealth Advisor at 888-643-3133.

About the Authors

Tom Allen

Tom Allen

Tom Allen is an Accredited Investment Fiduciary (AIF®), Certified Cash Balance Consultant (CBC) and a Chartered Financial Analyst (CFA®) Level III Candidate. Tom received his Bachelor of Science in Management Science as well as his Bachelor of Art in Philosophy from the University of California, San Diego.

Mark Hebner

Mark Hebner - Founder, Index Fund Advisors, Inc.  

Founder and President of Index Fund Advisors, Inc., and author of Index Funds: The 12-Step Recovery Program for Active Investors. He is a Wealth Advisor, with an MBA from the University of California at Irvine and a BS in Pharmacy from the University of New Mexico with a specialization in Nuclear Pharmacy.