Some of the key terms that investors come across when they look for investing in mutual funds are Net Asset Value (NAV), expense ratio, and fund performance. Unless they are planning to start by investing in a New Fund Offer (NFO), NAV plays the role of a critical metric in their investment decision. Let’s understand what NAV is, how to calculate NAV and the factors that affect NAV of a mutual fund.
What is Net Asset Value (NAV) in Mutual Funds?
NAV (Net Asset Value) is the price per unit of a mutual fund. It represents the market value of the scheme at a given time. NAV is updated every business day based on market movements and the fund’s performance. It is calculated as the difference between the total assets and liabilities of the mutual fund divided by the number of outstanding units.
A mutual fund’s NAV cannot be calculated during stock market hours as the underlying security’s price changes constantly. Therefore, NAV is calculated after the end of the trading day by using the closing prices of the fund’s securities for that day.
How to Calculate the Net Asset Value of a Mutual Fund?
Here’s the Net Asset Value formula:
Where:
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Total Assets represent the market value of all the investments held by the scheme.
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Total Liabilities represent the expenses, fees, and other obligations of the scheme.
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Total Number of Outstanding Units represents the total number of units issued to investors.
Investors do not need to know how to calculate NAV of a mutual fund, even though it is a good skill to learn, because fund houses are mandated by SEBI to publish NAV of their schemes on their own websites as well the Association of Mutual Funds in India (AMFI) website on every business day.
3 Factors that Affect Net Asset Value of Mutual Funds
The NAV of mutual funds changes daily and may be affected by these three factors:
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Market Movement: The upward or downward market movement affects the stock prices which directly influences the NAV of equity-oriented funds. Any change in interest rates or credit quality affect the bond prices which influences the NAV of debt-oriented funds.
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Dividends Paid by the Fund: The NAV of a mutual fund reduces when a mutual fund declares dividends. This happens because the dividend is paid from assets of the mutual fund.
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Expense Ratio of the Fund: All the expenses that comprise the expense ratio of the fund such as management fees, administrative charges, etc. are deducted from the assets of the fund. Therefore, it lowers the NAV of a mutual fund.
3 Benefits of Net Asset Value of Mutual Funds
While it is not recommended to make investment decisions purely based on the NAVs, there is no denying the fact that NAV can tell a lot about a mutual fund scheme. Here are 3 benefits of understanding a specific scheme’s NAV:
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Calculate Allotted Units: SIP investors can use NAV to find the number of units their investment buys based on the NAV at the time of purchase. They can easily comprehend why they are allotted more units when the NAV is low and fewer units when the Net Asset Value of mutual fund is high for the same SIP amount. This information can come in handy when they are using a SIP calculator to plan their future mutual fund investments. Lump sum investors can also get a good idea about the value of their investment at the time of buying or redeeming their units. This promotes transparency and standardisation.
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Compare Different Funds: Net Asset Value of a mutual fund changes on a daily basis and indicates the fund’s performance for the day adjusting for market movements, income from dividends, and expenses. While NAV is not a direct indicator of a fund’s profitability, it may be used to compare similar mutual fund schemes.
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Track the Current Value of the Portfolio: Investors can calculate the current value of their portfolio by multiplying the NAV of their mutual fund with the number of units owned. This information can be used when investors want to rebalance their portfolios.
What NAV Does Not Tell You
NAV is a critical metric in mutual funds, but it does not reveal:
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Future Growth Potential: Investors may not be able to derive the future growth potential of a mutual fund by looking at its NAV. They have to analyse other factors to see the fund’s potential to deliver returns.
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Fund Performance or Returns: Net Asset Value of a mutual fund does not show its profitability or historical returns. This is why a high NAV should not be equated to good performance and low NAV to the fund being undervalued.
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Level of Risk: The level of volatility of a mutual fund is not reflected in the NAV of a mutual fund. Investors must look at other metrics to understand the risk associated with their mutual fund investment.
In conclusion, NAV calculation is an easy and straightforward process that all investors must understand even though fund houses compute and publish NAV every day. This helps investors get a deeper understanding of their mutual fund investments, including the current value and the performance of the scheme. Investors can assess their investments and align them with their financial goals effectively by tracking the NAV of mutual funds.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.