NAV Erosion

NAV erosion occurs when an investment fund pays out distributions that exceed its total return (capital gains plus income), causing the fund's share price to decline over time. This is particularly common in high-yield covered call ETFs and synthetic income products.

How NAV Erosion Works

When a fund distributes more cash than it earns, that money must come from somewhere - typically the fund's principal. For example, if a fund earns 4% total return but distributes 10% yield, the remaining 6% effectively comes from selling holdings or reducing the fund's asset base.

Why It Matters for Income Investors

Many investors focus solely on yield without considering total return. A fund yielding 15% that loses 12% in NAV annually delivers only 3% total return - worse than a Treasury bill. The "income illusion" can make investors feel wealthy while their principal steadily erodes.

Warning Signs of NAV Erosion

• Distribution yield significantly exceeds the underlying index return
• Declining share price over multi-year periods despite market gains
• High proportion of return of capital (ROC) in distributions
• Fund uses derivatives or synthetic strategies to generate income

Which Funds Are Most Susceptible?

Tier 4 and Tier 5 products - particularly YieldMax single-stock ETFs and aggressive covered call strategies - carry the highest NAV erosion risk. These funds prioritize current income over capital preservation.