Course 103: Understanding Total Return
Distributions
In this course
1 Introduction
2 Income and Capital Appreciation
3 Distributions
4 Back to Total Return

As counterintuitive as it may seem, looking at a fund's NAV in isolation isn't always the best way to check up on its performance. That's because the NAV is vulnerable to changes that don't necessarily affect the true value of the fund.

For example, a fund's NAV will change whenever a fund makes a payment to its shareholders, otherwise known as a distribution. By law, mutual funds must distribute any income they have received from their stocks or bonds, as well as any capital gains they have realized from their holdings. (A fund "realizes" a capital gain when it sells a stock or bond for a higher price than when it was purchased.) But whenever a fund passes along either income or capital gains to shareholders, its NAV drops. If a fund with an NAV of $10 makes a $4 distribution, its NAV slips to $6.

Despite the shrunken NAV, shareholders are none the poorer. They still have $10: $6 in the fund and another $4 in cash. Unless they need the $4 in income to spend, most investors will reinvest their distributions back into the fund; in other words, they instruct the fund company to use that cash to buy new shares of the fund. Most total-return numbers reported in newspapers or on the Web, including those used by Morningstar, assume that you reinvest your distributions.

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