Understanding NAV (Net Asset Value)

Ravi and Priya were interested in the valuation of mutual fund investments after reading the previous chapter on index funds and exchange-traded funds (ETFs). They discovered that whenever the topic of mutual funds was brought up, the phrase NAV kept coming up.

To ensure they make wise choices, Ravi and Priya explore the definition of NAV, how it is calculated, and its importance for monitoring their investments.

Consider the NAV a mutual fund's "stock price" instead. In other words, the price of a single fund share fluctuates throughout the day based on the company's performance, much like the price of a stock. NAV is determined at the end of each trading day of the fund. Consequently, unlike the stocks/ETFs that trade during the market hours, mutual funds compute and announce the NAV only after the market is shut. This means you cannot see any daily fluctuations in the NAV. The price you pay for units is the NAV, the value at the end of the trading session.

The NAV is calculated by taking the total value of the fund's assets minus any liabilities and dividing that by the number of units or shares outstanding. The formula looks like this:

NAV = (Total Assets - Total Liabilities) / Total Outstanding Units

For instance, if the NAV of a mutual fund is ₹100 and you buy ten units, you will invest ₹1,000. If the very next day, the NAV rises to ₹ 110, then your investment value increases to ₹1,100. If it falls to ₹95, your investment will be valued at ₹ 950. So, this is where the NAV influences your returns.

A high NAV is an indication but not a sign of the underlying quality of the fund. It represents the current high value of the fund's investments. It needs to convey something regarding whether the fund will continue or not. More important is its performance, reflected over time, how profitably it has grown. Even with a low NAV, that may be a good area of investment if the financial value of the fund or a particular scheme has grown over time.

Some funds start with a much higher NAV from the get-go. This does not imply that the fund is "superior" to any other fund; it just means that its net asset valuation started higher. If you are buying into a fund, you should be fine with the NAV in and of itself. You want to see the performance of the fund over an extended period.

Also, NAV doesn’t account for dividends or interest payments made by the fund. These are distributed separately and are added to the overall return. So, the NAV only reflects the market value of the assets in the fund, not the extra returns you might get from dividends.

Investors often use NAV to track how their investments are performing. If the NAV is rising consistently, it’s a sign that the value of the underlying assets is increasing. But remember that, just like any investment, the NAV can go up and down. Therefore, it is more important to consider long-term trends than short-term fluctuations.

Conclusion:

Knowing how the NAV works and how it affects their mutual fund investments will help Ravi and Priya to realise the type of fund an investor chooses will affect how well their mutual funds perform. The NAV does not solely determine the actual value of an investor's investment.

The next chapter gives an overview of sectoral and thematic funds, which enable investors to concentrate on certain industries or market trends. Understanding this would be very important for both Ravi and Priya in building their strategy behind the investment.