InvestorQ : How does a NAV of a mutual fund change through the dividend received on equity holdings?
Shreya Mashelkar made post

How does a NAV of a mutual fund change through the dividend received on equity holdings?

riya Ranade answered.
2 years ago
A mutual fund's NAV is calculated by dividing the value of the fund's assets by the number of the fund's outstanding shares. Changes in NAV depend upon the treatment of the dividends received from equity holdings.

Let me explain this briefly-
Most mutual funds come in 3 options you can choose from the dividend, dividend reinvestment, and growth. For any given fund, all 3 options share the same investment strategy - the difference lies in how the fund profits are returned to you. Let’s take a closer look:

Dividend option - Here, the profits generated by the fund are periodically paid to investors in the form of dividends. If you need regular payouts, then this type of investment might make sense for you. When profits are generated and paid in the form of dividends, the mutual funds’ NAV goes down, because you have taken the profits out of your fund. In other words, in a mutual fund dividend income is distributed when the mutual fund scheme has booked profit in the portfolio and therefore, can be regarded as redemption, which invariably leads to a lower NAV as compared to say, the growth option in the same scheme. For example, if you buy a unit of mutual fund whose NAV is Rs.100. Over the year, this fund performs well and reaches a value of Rs.105. Now, when the fund house decides to pay a dividend of Rs. 3 to its investors, the NAV of the fund will fall back to Rs.102.

Dividend Reinvestment option - In this option, the dividend that is declared by the fund manager is not actually transferred to the investor. The dividend is reinvested automatically by the fund manager to buy more fund units at a lower NAV. The additional units that are bought on your behalf, are then transferred to your account. In this case, the capital appreciates due to increasing in the number of units over a period of time.

Growth option – Here, the profits generated by the mutual fund scheme are invested back in the fund. Hence it does not provide any payouts. As the profits generated are invested back in the fund, the fund’s NAV (and your investment value) increases faster over time. With the profits as well as the initial investment compounding over time, this makes a huge difference over a multi-year period.