Sometimes, you may notice that your mutual fund’s share price declines when the market goes up. While there may be legitimate reasons for this trend, it doesn’t always mean that you’re holding onto a bad investment.
Mutual funds may go down when the market goes up because the market performance is updated more frequently than a fund’s NAV. Or your fund has just paid dividends. It could also be due to the type of mutual fund you own. A mutual fund doesn’t always become a bad investment if it goes down.
Read on for an in-depth discussion on why mutual funds go down when the market goes up and whether to get concerned if it happens.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
3 Reasons Mutual Funds Go Down Despite Market Going Up
Described below are the top three reasons for a mutual fund to go down even when the broader market is going up:
Mutual Fund Prices Aren’t Updated As Often as the Market
One of the main reasons why investors might notice their funds going down as the market goes up is that mutual fund prices are not updated as often as the market. If you closely monitor the market throughout the day, you’ll notice that its performance changes every few seconds, which is how often the market’s performance is updated.
On the other hand, mutual funds typically update their prices once a day, typically hours after the market closes for the day. Fund managers and their teams must calculate the Net Asset Value (AKA, the per-share price of the fund), which is a labor and time-intensive process.
Calculating a fund’s Net Asset Value (NAV) involves summing up the value of its holdings, subtracting expenses from that figure, and then dividing the result by the number of outstanding shares. On paper, this seems simple.
However, the reality is that even with supercomputers and math experts, it takes a lot of time and effort.
The fact that the market is updated more frequently than a mutual fund’s NAV can make it seem like your fund’s price is going against the market. To illustrate this, here’s an example.
Suppose you check the market action at around 10 AM PST and notice that the S&P 500 has gained 10 points. Delighted with this, you check your mutual fund’s price action, only to find it down $1.25/share.
You might think that the fund is underperforming compared to the market and even be tempted to dump it. However, the truth is the $1.25 loss you’re noticing at the moment was realized the trading day before.
How the fund performs at 10 AM (when you check both the fund’s and the market’s performance) is still a mystery because the day’s NAV is yet to be reported. At the end of the trading day, your fund will update its NAV and potentially reflect a trend that’s more consistent with the trading day’s market performance.
The Fund Might Have Just Paid Dividends
As you might have gathered from the previous section, a mutual fund’s NAV reflects its listed price. Typically, the NAV drops whenever a mutual fund pays dividends, an effect that’s always translated to the share price.
Sometimes, NAV drops triggered by dividend payouts can make it seem like the mutual fund in question is dropping against the market. However, this couldn’t be farther from the truth. Such drops are usually temporary and don’t affect the total value of your investment in the fund.
Besides, the NAV wouldn’t be the best way to measure the performance of your mutual fund because it doesn’t paint the whole picture.
A more comprehensive measure would be the total return. Expressed as a percentage of the average NAV over a certain period, the total return captures the effects of distribution and appreciation, providing a more accurate reflection of a fund’s return on investment.
It’s also worth mentioning that NAV drops triggered by dividend payouts present an opportunity to grow your investment. With the share price down, you can choose to reinvest your payout for more shares.
The bottom line?
If you notice your fund’s share price dropping all of a sudden when the market is going up, check whether the fund has paid out dividends before you opt to dump your shares. Dividends are likely the cause of the drop in share price if it happens between year-end and early January because that’s when most funds make distributions.
It Might Have Something To Do With the Fund You Own
The type of mutual fund you’ve invested in can also cause a mismatch between your fund’s performance and the market’s. Type means whether your fund is an index fund or actively managed.
Typically, an index fund’s portfolio comprises specific bonds or stocks put together to match a market index (such as the S&P 500) in both performance and composition. In simpler terms, index funds look to match the market’s risk and return. The rationale is that the market will always perform better than any individual investment in the long run.
Since an index fund mimics a market index, its performance is often in sync with market trends, which can’t be said of actively managed funds.
The performance of an actively managed mutual fund varies from the market because its holdings are different from the portfolio of a market index. Various market indices might differ in performance, too, because their holdings are different. That’s why it’s common for NASDAQ to go up as the S&P 500 drops, and vice versa.
So on any given day, an actively managed fund might go down when the market goes up depending on its holdings’ performance against the market. However, this trend shouldn’t put you off if it’s short-lived, as there’ll also be moments when your fund gains as the market goes down.
When To Worry About Funds That Go Down Against the Market?
You should be concerned if your mutual fund keeps losing value as the market gains for over a week. If the cause isn’t one of the three factors discussed above, it might be time to re-evaluate the decision to hold onto the fund’s shares.
Some of the legitimate reasons you might want to dump the fund include:
- To rebalance your portfolio. With time, your mutual fund might change its asset allocation in response to market trends, which can sometimes increase the level of risk you’re exposed to as an investor. If this happens, it might be necessary to rebalance your portfolio risk by selling shares of such funds and reinvesting in funds whose asset allocation suits your risk appetite.
- To fix mistakes you might have made choosing the fund. It’s easy to miss a few things in the prospectus and invest in a fund that’s more volatile than you prefer. Such funds will fluctuate greatly, and it might help to dump them if they don’t fluctuate favorably for a significant period.
- Management changes. Management changes can negatively affect a fund’s performance if the incoming manager isn’t as capable as their outgoing counterpart. Even without personnel changes, some managers may undergo a style drift, changing their investment strategy over time. If either occurrence causes your mutual fund to drop when the market keeps rising, it might be time to invest in a different fund.
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Conclusion
As we’ve seen in this post, a mutual fund whose share price goes down when the market goes up doesn’t instantly turn into a bad investment IF that trend is short-lived. Of course, some mutual funds may lose their value for legitimate reasons that you should be concerned about.
Whichever the case, you’ll want to find out the underlying cause of the sudden change in your fund’s price before you make any decisions.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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