Before diving into mutual fund NAV, you must first understand that all mutual fund transactions in India take place in the form of individual shares. Each unit’s price is the NAV, which stands for a mutual fund’s Net Asset Value. That means NAV is the basis of all mutual fund investments. As multiple types of mutual funds invest in bonds and stocks, their investment value depends on the scheme, which changes from time to time. That indirectly impacts their NAV in a way similar to stock prices. However, one thing to note is while equity share prices fluctuate several times in a day, NAV is calculated at the end of each trading day, changing the NAV only once.
Let's explore more about NAV and what all investors should know about it.
Impact of Mutual Fund NAV on Investments
Here is an example to better understand the impact of NAV on mutual fund investments:
Support you invest ₹ 4000 in a debt mutual fund of NAV ₹20. At this price, you can purchase 4000/20=200 debt mutual fund units. If you decide to invest ₹ 4000 more in the same mutual fund a week later, and if its price has increased to ₹ 25, you can purchase 4000/25=160 units now.
As evident, even if you invest the same amount in both instances, the number of mutual funds you buy decreases as the NAV increases. Similarly, if the NAV decreases, you can buy more units for the same amount. Finally, the mutual fund NAV forms the basis of rupee cost averaging, one of the most sought-after benefits of SIP investments.
Impact of NAV in a Fund Performance
Most investors look for an asset with a low NAV because they believe such funds are cheaper and will deliver better returns in the future as their NAV increases. However, a mutual fund's NAV has no relation to its performance in the future. For instance, the lower NAV of debt mutual funds does not make them a lucrative investment. An asset’s NAV merely indicates how it has performed in the past few years. Therefore, it cannot be an investor’s determining factor when choosing a fund to invest in. One must check the returns to make informed decisions.
Factors Affecting NAV Calculation
Based on the NAV, mutual funds allocate units to each investor. The bigger the investment, the more units the investor gets. After collecting money from several investors, fund managers invest in bonds, stocks, debt mutual funds, and other financial instruments based on the scheme’s investment goals. The total investment value impacts the mutual fund's total assets. As the price of these instruments changes, the total assets also change.
Another factor affecting the NAV is the liabilities of a mutual fund scheme. These include the costs related to the scheme management. The AMC administering the fund must cover various costs comprising the mutual fund liabilities, including custodial expenses, marketing budgets, administration fees, brokerage commissions, initiative expenses, etc. One must deduct these liabilities from their total value to calculate a mutual fund's NAV.
Formula to Calculate the Net Asset Value
Here is the formula to calculate the NAV of a mutual fund:
NAV = (Total Assets – Total Liabilities) / Total number of outstanding units
In the above formula, the total number of outstanding units refers to the total number of units the mutual fund distributes to its investors.
Importance of NAV for Investors
Investors trying to time the market prefer making lump sum investments when a fund's NAV is low and redeeming them when it increases. The objective is to maximise profits from the investment. Although it is a nice strategy, implementing it practically is challenging as market movements are too complex to predict. So, rather than focusing on NAV, investors should focus more on being systematic and staying invested for a long time through SIPs.
SIP investors can leverage rupee cost averaging to reduce the impact of NAV changes on the investment. Additionally, it gives more time for fund growth, allowing investors to benefit from compounding interest.
Now that you know what NAV mean and its calculation method, remember that it determines the number of units allotted for the investment. Rather than concentrating on the NAV of the acquired units, one must focus on how much their investments appreciate in value. Simply put, appreciation of the NAV is more crucial than the NAV itself. With this information, investors can now make smarter investments in different types of mutual funds and earn the expected returns.