How Important is NAV for Valuing Mutual Funds?
Created on 04 Sep 2019
Wraps up in 4 Min
Read by 3.2k people
Updated on 14 Jun 2021
A mutual fund is that one perfect asset class for a lot of us. It is not as faster a ride towards our goals but ensures that we don’t lose sight of the track. Mutual funds pool the funds from people and invest them in various arenas focused on fulfilling our financial goals. But analyzing and picking the right fund is where the pain lies.
A lot of investors simply follow the NAV without having a good idea as to what they mean. Just like wings for a bird, NAV plays a crucial role when it comes to Mutual funds. But there revolve loads of questions about what it means and how an investor can make maximum use of the same. This sort of dilemma is usual for any newbie and, the following article will rightly guide you in getting over it.
What is NAV?
The NAV or the Net Asset Value of a mutual fund tells an investor what the price of each unit of a specific fund is. These are arrived at by calculating the market value of the underlying assets into which the fund is put into such and equities and then deducting liabilities. You will arrive at the Net asset value for the entire fund to calculate for a single unit divided by the number of outstanding units.
So the formula for the same goes as follows,
Net Asset Value = (Asset – liabilities ) / Number of total units outstanding in the market
The fund includes securities like debentures, bonds, etc and other assets & liquid cash held by the fund house. The liabilities include all the interest and management fees that accompany the fund.
Usually, fund houses are mandated to release the same either on a weekly basis or a daily basis. Adding to that, new funds offer or NFO’s are offered at a NAV starting at Rs 10. However, unlike the price of shares, the NAV does not symbolize the demand and supply of the same in the market.
How important is NAV?
There are a lot of false assumptions around the use of NAV. Let’s bust it once and for all. People are of the false assumption that a high NAV translates to a healthy fund and one a lower one means that the fund is not performing well. This is not true.
NAV simply tells you the price of the units purchased. Hence, a higher NAV means you will be getting a lower unit of funds, and on the other hand, a lower NAV will fetch you a higher number of funds. We see the same with an example.
Assume there are two funds, X and Y. Both have an overall value of 1,00,000. While the NAV of fund X is Rs 10, that of fund Y is Rs 50. So the number of units you will be getting under fund X is 10,000 units (1,00,000/10), and the number of units provided under fund Y will be 2000 units (1,00,000/50). However, as mentioned earlier, neither will replicate the wellness of the fund.
NAV’s are usually assigned at the end of the day. If an investor makes an order to buy before 3 pm, then he will be given the NAV of the previous day. On the other hand, if he makes an order after 3 pm, he will receive the NAV of the current day.
NAV in different funds
The role of NAV varies from fund to fund. We will take a look at the same below.
NAV is of high significance to the open-ended funds. The price of an open-ended fund depends to a great extent on this. Say, for example, the NAV of a particular fund is 50,000. You invest 10,000 and acquire the units of the same. Now the next person will have a NAV of 60,000. Similarly, any withdrawal from the fund will also be reflected in the NAV.
Close-ended funds are less dependent on NAV. Since they are closed, they only allow a certain number of shares. Though they are traded in the open market, the role of NAV is minimal.
Interval funds are a combination of both. Funds are traded on stock exchanges while they are closed and are traded or redeemed when they are open on the basis of the NAV.
So what should you do?
NAV is going to be on the move consistently, irrespective of your likings. Hence, it’s advisable to be aware of it but offer it relatively lesser importance. An investor should properly analyze every aspect of the mutual fund before putting his or her money. And in the future, if the investor finds a good fund, then he should simply go for it rather than worrying about the NAV.
Along the same lines, when the NAV of your fund falls drastically or changes from the expected path, your first instinct should be to remain calm. And then ignore the same. Don’t ever panic sell, assuming a fall to be deadly. Instead, run a quick analysis before you take any drastic decision.
Hope you will refrain from making any errors when it comes to NAV like many others in the market after this article. Ultimately stick towards your financial goals and profile and pay less heed to the NAV of a mutual fund.
Anyway, have you ever mistaken a falling NAV for a bad fund performance?
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