When you start investing in mutual funds, you will come across the term NAV continually. It is undeniably the most important number and will impact the value of your investment, yet many beginners will find what NAV is. In its simplest form, knowing the NAV in Mutual Funds will let you know how your investment is performing.
This guide is intended for mutual fund investors to help simplify what Net Asset Value is and why it matters to you as a novice investor.
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What is Net Asset Value?
NAV means Net Asset Value. It is essentially the per-unit price of a mutual fund scheme on a given day.
To view it more visually, think of a mutual fund as a cake fund, and the NAV is the price of one single slice of cake.
A mutual fund invests a pool of money from many thousands of investors.
This pool of investor cash is then invested into different securities, such as stocks, bonds, and cash - these items collectively are called the mutual fund assets.
The total market value of these various securities will change day to day, based on market activity.
To offer an exact idea of ownership, the mutual fund divides its total value into units. And NAV is the price for one such single unit.
Important Point: When you buy into a mutual fund, you buy units at the current NAV. Likewise, when you redeem (or sell) your investment, the fund will buy your units back at the current NAV.
If you want to learn more about the underlying assets, consider checking out the blog, Equity Market Basics, or you can take a more structured course, such as the Stock Market Beginners Course for Investors and Traders.
How is NAV Calculated?
A fund house (Asset Management Company or AMC) will calculate the NAV right after the market closes for the day. That way, you’re capturing all the price changes for the underlying assets after the market price adjustment that day.
The formula to calculate NAV is actually very simple:
NAV = Total Market Value of Assets - Liabilities / Total Number of Outstanding Units
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Let’s break apart the components to understand how NAV is made:
Total Market Value of Assets: This is the market value of all the stocks, bonds, cash, and more in the portfolio. Because the price of stocks and bonds changes daily, the value will change each day because part of the NAV calculation is based on the total market value of assets held at the end of the day. If you want some guidance on how to calculate and assess a company's overall wealth, then check out How to Analyze a Company's Balance Sheet.
Liabilities: These consist of the fund's expenses, including management fees (e.g., the expense ratio), transaction costs, and any other expenses related to the fund's operation.
Total Number of Outstanding Units: This refers to the total number of units already issued to all of the fund's investors.
Example for Beginners:
This is the Net Asset Value at which all transactions (purchases and redemptions) for the day will be executed.
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Why is NAV Important in Mutual Funds?
The Net Asset Value is not just a number, but a very important figure for several reasons that can impact your investment. Appreciating this is important for a beginner's guide to NAV.
1. It Will Determine Your Unit Allotment
When you invest a lump sum amount, the NAV in Mutual Funds will determine how many units you will receive.
Units Allotted = Investment Amount / NAV
Example: If you invest Rs. 10,000 and the NAV is Rs. 20, you will be allotted 10,000 / 20 = 500 units.
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2. It is the Benchmark for Performance
The change in a fund's NAV over a period of time (day/week/year) is how you will measure the return or loss of the fund. For example, if a fund has an NAV that rises from Rs. 10 to Rs. 12 over the course of the year, you could say the fund achieved a return of 20%.
Higher NAV is not equal to Better Fund: One common misconception beginner investors have is that a fund with a lower NAV is 'more attractive' or 'less expensive' than a fund with a higher NAV. This is a myth. NAV is just a price, as the performance of funds is based on the rate of change (returns), irrespective of when the 'starting NAV' might have been.
3. It Governs Transactions
The NAV at which you buy or redeem your mutual fund is dependent on the cut-off time as specified by SEBI.
If you place the transaction request before the cut-off time (generally 3:00 PM IST for the equity fund), you are entitled to get the NAV declared on that business day.
If you place the request after the cut-off time, you will get the last NAV price stated on the next business day.
This built-in fairness and transparency ensure all mutual funds adhere to set cut-off times.
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Conclusion
In the end, the NAV of a mutual fund is the foundation of mutual fund valuation. For a beginner investor, understanding the idea of Net Asset Value is the foundation of being an informed investor. Remember, this is simply the accurate, daily-reported value of a single unit of the fund, or what its performance looked like from its holdings during the day.
Do not just focus on the fund's NAV absolute numbers, but instead always look at the fund's performance history in relation to its investment objective.
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