NAV – The Effect of A Capital Gain Distribution On A Fund’s Price

compiled by Dib Mossavi

If your fund is down when the market is up, the fund might have just paid a capital gain.

  • What is a capital gain? When you sell a capital asset — such as a stock or a bond — for more than you paid for it, you make a profit, or experience a capital gain. So if you buy a stock for $100 and later sell it for $120, your capital gain is $20.

    When a fund sells securities at a profit, the sale also generates a capital gain. Two types of capital gains are realized by our funds — short-term and long-term. Net short-term capital gains are distributed to shareholders as income dividends and are taxed at ordinary income tax rates. Long-term capital gain distributions are taxed at a maximum rate of 15%.

    Fund managers (the PCEF as in the case of my shares) buy and sell securities throughout the year, sometimes at a profit, sometimes at a loss. When profits outweigh losses, they accumulate and contribute to the rise of the Net Asset Value (NAV) of the fund’s shares. When that profit is paid out to shareholders, its NAV, or share price, will be reduced by the amount of the distribution.  These distributions, which typically occur once or twice a year, are made primarily for tax reasons.

    However, if you reinvest the distribution, as most shareholders do, the number of shares in your account will increase so that the total value of your account will not be affected by the distribution.

    • For example… Say a fund share sells at a NAV of $10. If sales of the fund’s securities have resulted in the fund making a capital gain distribution of $2 a share during the year, $2 will be deducted from the NAV and paid to shareholders on a specified date. On that date the fund share price will decline to $8.
    • Don’t worry — you haven’t lost any money. You still have $10 in value — $8 in the fund’s Net Asset Value, and $2 in your pocket or reinvested in the fund. And if you do automatically reinvest your capital gain distribution, it buys you additional fund shares at the new, lower price of $8. These additional shares compensate for the drop in the NAV, so the total value of your account doesn’t change. (Of course, if there is a decline in the market at the same time, you may still see a drop in the total value of your account.)

For example… If you have 100 shares in your account when the NAV is $10 a share, your account value is $1,000. If the fund pays a capital gain distribution of $2 a share (or $200, since you have 100 shares), the NAV drops to $8 a share and your original 100 shares are now worth $800. However, if you automatically reinvest your capital gain distribution, the $200 distribution buys you $200 worth of shares — at $8 per share. The distribution therefore adds 25 shares ($200 divided by $8) to your account, so you now own 125 shares worth $8 each, for a total of $1,000, which was your original account value before the capital gain distribution was paid.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.

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