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Q

If I buy $1 million worth of a tax-free bond fund shares (say, 133,333.33 shares at $15.00 per share) that is paying a monthly dividend of 5% ($4,166), and next month the NAV drops to $14.50 per share, will I continue to receive dividends of 5% of $1 million ($50,000)? What happens if the NAV increases to $15.50 per share? Can I sell the NAV profit and continue to receive the original 5% of $1 million, the original purchase price?

A

James A. Klotz responds:

Let’s start with the arithmetic: A $1 million investment in the hypothetical bond fund you describe at $15.00 per share would result in you owning 66,666.66 shares.

Bond funds pay dividends on a per share basis (in your example .75 equals $50,000.00 annual income or 5.00%). This dividend remains constant unless it is cut or raised by the mutual fund.

If the dividend has not changed, a reduction in the NAV would not affect your annual income, since you will continue to own the same number of shares paying at the same rate. This would also be true if the NAV increased because you would likewise be receiving your dividend based on the same number of shares.

If you decided to take your profit by selling the appropriate number of shares to reduce your investment to the original $1 million, your annual income would be reduced proportionately since the dividend per share would now be paid on fewer shares.

In this example, if the shares appreciated to $15.50, your original investment would be worth $1,033,333.25. To take your profit and reduce your investment to the original $1 million would require selling 2,150.53 shares. Since you would then own 64,516.66 shares, this reduction in shares would cause your annual income to drop to approximately $48,387.50 (.75 x 64,516.66).