Mutual funds have emerged as a popular investment choice for individuals seeking to grow their wealth. One of the key metrics that investors closely monitor is the Net Asset Value (NAV). In this article, we will understand what NAV is and how it is calculated.
What is NAV?
Net Asset Value (NAV) represents the price per unit of a mutual fund scheme. Essentially, NAV reflects the performance of a mutual fund scheme. Usually, the unit cost of a mutual fund scheme begins at INR 10 and increases/decreases as the value of underlying assets changes. Thus, the NAV value changes every day.
A mutual fund can be bought/sold based on NAV. However, the NAV does not change constantly, like share prices during trading hours. The NAV of a scheme is determined on a daily basis and computed at the day's end on the closing price of all underlying securities after making appropriate adjustments. Moreover, the expenses (known as TER), like fund management, administration fees, etc, are charged proportionately against the scheme's assets and adjusted to the scheme NAV.
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How to Calculate NAV in Mutual Funds?
The NAV is calculated by subtracting the fund's liabilities from the total market value of its assets and then dividing the result by the number of outstanding units.
The formula to calculate is as follows:
Let us break down each component:
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Total Assets: This encompasses the market value of all the securities, cash, and investments held by the mutual fund.
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Total Liabilities: These are the expenses, fees, and other financial obligations associated with the fund.
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Number of Outstanding Units: This is the total number of units a mutual fund issues.
Example
Let us understand how to calculate the NAV of a scheme with the help of an example –
Suppose a mutual fund scheme has assets valued at 120 crores, and the liabilities are valued at 9 crores. The total outstanding units are 10 crores. By applying the formula –
NAV = (1,20,00,00,000 – 9,00,00,000)/10,00,00,000 = 11.1
Therefore, the NAV per unit of the scheme is 11.1
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Role of NAV
Understanding the critical role of NAV in mutual funds. It serves the following purposes:
Valuation: NAV helps investors determine the current value of their investment. You transact at the prevailing NAV when you buy or sell mutual fund units.
Benchmarking: NAV enables investors to compare the performance of different mutual funds. In other words, you must check the appreciation of a scheme NAV rather than just the NAV of two schemes for comparison. Thus, it helps to analyze historical NAV growth and expense ratios.
How is NAV Relevant for Investors?
NAV determines the price at which investors can enter or exit a mutual fund. A lower NAV does not always signify a weaker fund. It only shows the current value of units. Instead, the fund performance or returns play an important role in comparing funds.
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Moreover, a higher NAV only shows the positive performance of the scheme, which was issued some time ago. Also, a higher NAV means the investor will receive fewer units, and a lower NAV means the investor will receive a higher number of units.
Let us understand with the help of an example –
The above example shows that the NAV of Scheme B is double that of Scheme A. However, the investment value remains the same after one year for both schemes because their returns were identical. Therefore, buying a fund with a lower NAV is not the right strategy. It is important to gauge the performance or returns of the fund because NAV is not the appropriate indicator of a fund's performance.
NAV Allotment for Different Types of Schemes
The NAV allotment process varies across different mutual fund schemes. In open-end funds, NAV is computed daily, and investors transact at that day's NAV. In closed-end funds, NAV is calculated less frequently, and investors may trade units at market prices, potentially at a premium or discount to NAV.
Investment Timing & NAV Relationship
For every mutual fund scheme, SEBI has defined a cut-off time. To be eligible for the NAV on the same day, you must place a request before the cut-off time. The Indian mutual fund industry has adopted the concept of realization-based NAV. There are two steps involved in buying/selling mutual fund units -
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Placing a request/debiting money from your bank account
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And the money reaches the fund house's collection account.
With effect from February 1, 2021, you will receive the NAV for the day on which the funds reach the fund house, irrespective of whether the amount is debited from your account prior to the cut-off time. This is commonly referred to as realization-based NAV. Below are the cut-off timings and regulations applicable to different mutual fund schemes -
The cut-off time for both the purchase and redemption of debt and equity mutual funds is 3:00 PM. However, for liquid and overnight mutual funds, the purchase cut-off time is 1:30 PM, and the redemption cut-off time is 3:00 PM.
Conclusion
Net Asset Value (NAV) is not just a number; it is a crucial indicator of a fund's value and liquidity. It is advisable to consider investing in a mutual fund that aligns with your specific investment goals and risk tolerance, rather than focusing on whether its NAV is higher or lower. After making an investment, monitor the NAV change to assess its historical performance. Thus, this information empowers you to make well-informed decisions about your investments.
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