Net Asset Value or NAV is an investment fund’s market value for each of its units. Essentially, the NAV represents the actual price at which an investor can either buy or sell units of any mutual fund.
The net asset value is computed by dividing the total net assets of a mutual fund scheme by the total number of outstanding units. Note that net assets can be described as the total value of securities held by a mutual fund scheme excluding liabilities. However, the mutual fund NAV of mutual fund schemes changes daily based on the performance of their underlying securities.
On that note, let us dive deeper into the topic to gain a better understanding of mutual fund NAV or Net Asset Value and its importance.
The formula of Net Asset Value
Like discussed, NAV of mutual funds is the total net assets by total outstanding units. In a simpler representation,
The formula for a mutual fund’s NAV calculation is straightforward:
Mutual Fund NAV= (Total assets – liabilities) / Total number of outstanding units
Example of NAV Calculation
A mutual fund has total assets of Rs. 100 crores and total liabilities of Rs. 10 crores. Additionally, the number of outstanding units of the mutual fund scheme is 1 crore. Hence, as per the formula –
Mutual Fund NAV = (Assets – Liabilities) / Total Number of Outstanding Units
= (100 – 10) / 1
= Rs. 90
NAV of the scheme is Rs. 90
Importance of Net Asset Value
Net Asset Value or NAV is a crucial measure that indicates the entire shareholder or unitholder equity share. It’s computed by dividing the entire value of cash and securities in a mutual fund’s portfolio, excluding any liabilities, by the number of outstanding shares.
The net asset value is significant because it shows how much a single share of the mutual fund should be worth. Typically, the higher the NAV or the NAVPS, the greater the value of the mutual fund or firm. A mutual fund will issue and redeem units by pricing them as per the fund’s NAV.
When choosing a mutual fund for investing, individuals should keep in mind that the daily variations in NAV are irrelevant. Additionally, to measure the success of a mutual fund, it is recommended to look at its annualized return across different time periods.
Common Misconceptions about NAV
Though mutual fund NAV is among the most essential elements that investors evaluate when they invest in mutual funds, there are some NAV myths that confuse them. This is why it is important to be aware of them in advance.
Myth 1: A Low NAV Is Better as It Lets You Buy More Units
One common misconception regarding mutual fund net asset value is that it’s better to invest in fund schemes with lower NAVs as it can allow you to buy more units in the schemes. This mutual fund NAV myth is probably why many investors park their money into New Fund Offers or NFOs. However, the NAV of a mutual fund does not affect the investment returns generated by these schemes.
Myth 2: A High Net Asset Value Is Bad
Another prevalent myth regarding mutual fund NAV is that a high net asset value is a bad thing. This is also incorrect. As discussed, the NAV of a mutual fund doesn’t have any bearing on the performance of the underlying securities. A mutual fund scheme’s returns depend on the performance of those underlying securities.
Myth 3: A Higher NAV Scheme is Expensive
This is also another prevalent assumption concerning mutual fund NAV. This isn’t the case as the value of the underlying securities determines the price of a mutual fund plan.
Myth 4: A Fund Scheme With A Lower NAV Is Less Risky
The mutual fund scheme’s risk is based on the performance of its underlying securities, not its net asset value.
Myth 5: A Mutual Fund Scheme’s NAV Remains Constant
A mutual fund scheme’s NAV adjusts on a daily basis that too as per the performance of its underlying assets.
Myth 6: The Lower the Cost-To-Income Ratio, the Better the Mutual Fund Scheme
While lower expense ratios are preferable for investors, this does not indicate that schemes with lower expense ratios will always outperform the schemes with higher expense ratios.
Myth 7: Mutual Funds With Higher Returns are Always Better
While higher returns make a mutual fund most lucrative for investors, it does not mean that mutual fund schemes with higher returns will always offer higher returns.
That said, let us now take a quick look at the factors that one should consider when investing in mutual fund schemes.
Factors to Consider When Investing in Mutual Funds
- Risk tolerance: It’s crucial that you ascertain your risk tolerance before parking your money in mutual funds. Such a strategy will enable you to choose the right type of mutual fund which matches your investment goals and overall risk appetite.
- Investment goals: Make sure to have a clear understanding of your investment goals before you decide to invest in mutual funds. This will allow you to opt for the right type of mutual fund that will let you scale your investment goals better.
- Expense ratio: The expense ratio is essentially the annual fee that a mutual fund company levies on investors for managing their investments. That said, you should opt for a mutual fund scheme with a low expense ratio to maximize your returns.
- Fund performance: Weigh in the past performance of your chosen mutual fund scheme before investing in it. Such a move offers you an idea of how the scheme has performed and if it will continue to generate desirable returns in the future.
- Asset allocation: Dividing one’s investment portfolio across different asset classes like cash, stocks, bonds, Unit Linked Insurance Plan is important for a balanced risk-reward aspect. However, you should still choose a mutual fund that aligns with your personal asset allocation strategy and risk appetite.
Keeping these aspects of mutual fund NAV in mind will help you streamline your investment strategy better. Additionally, having a clear understanding of the concept will help you distinguish investment myths from facts easily and plan the same better.
