Mutual Fund Distributions

The world has truly become our classroom, and I figure that if our students can study anywhere, well then why not an outdoor lesson?
I just got off the phone with one of our students. He was asking me a question about mutual fund distributions and the explanation really helped him. So I figured, why not record a quick video for the benefit of all our students? Here is the question:
All else being equal, what would happen if a mutual fund made a distribution and unit holder Harris decided to reinvest the distribution he received back into the fund?

a) The NAVPU would decrease, Harris would have more units
b) The NAVPU would increase, Harris would have more units
c) The NAVPU and the number of units the Harris owns will remain unchanged.
d) Harris will own more units and the NAVPU will remain the same

The nuts and bolts of each answer is, “How would it impact the NAVPU and the number of units Harris would own?”.

Let’s first start with the distribution. In our Study Guide we describe a mutual fund as a huge portfolio to which many investors contribute. But for this question, forget about that for a moment. That’s way too confusing. Let’s pretend it is 100% your own portfolio.

What would happen if you took money out of that portfolio to pay yourself a distribution? Obviously, the value of the portfolio would go down, right? You are taking money out. The same holds true for a mutual fund. When they make a distribution, the NAVPU falls by the amount of the distribution paid for each unit. Now with this in mind, answer ‘a’ must be the right answer because it is the only one that says the NAVPU would decrease. The next part of answer ‘a’ is quite logical too. If Harris uses a Distribution to buy more units, then he obviously receives and owns more units.

I hope you found this video lesson helpful and good luck on your upcoming exams.