What is NAV?
NAV stands for Net Asset Value of a mutual fund scheme which is precisely its book value or book price. In essence, it is the value per unit of a mutual fund scheme. The NAV is calculated as follows:
NAV= (Assets - Liabilities)/Outstanding units
Assets include stocks, bonds, cash, accumulated interest as well as dividend held by the fund. The 'per unit' market value of all the assets is taken into consideration.
Liabilities include the unsettled debt and accumulated expenses
Outstanding units include the total number of units held by all the investors as a whole
A misconception held by many in the investing community is – the lower the NAV of a mutual fund scheme, the better the returns. However, this is not accurate and investors should nip this myth in the bud as mistaken beliefs and investments do not get along well. It is better to be well informed while taking major investment decisions.
Let's get this straight, lower or higher NAV has got nothing to do with returns. Therefore, investors should possibly get rid of this fallacy that they have believed in, all these years. NAV is inversely proportional to the number of units the investor invests in. This in no way affects the fund value as opposed to the popular conviction. Investors need to understand that although the number of units reduces with an increase in NAV, the total amount invested still remains the same. The tussle between various mutual fund schemes; can only be solved by the respective funds in question, primarily based on how they have performed over the past few years. If investors want to decide between two mutual fund schemes with identical portfolios and different NAVs, it would make sense to evaluate the quality of both the funds instead of focusing on the NAV alone. Taking a look at factors such as fund management, past returns provided by the fund and a general performance review of the fund in the previous years should ideally be on the to-do list of most wise investors. Here's a quick example highlighting the fact that NAV does not make that much of a difference.
Consider two mutual fund schemes of the same kind Fund X with NAV of 20 and Fund Y with NAV of 50.
Investment amount = 10000
Number of units in Fund X = 10000/20= 500
Number of units in Fund Y = 10000/50 = 200
Although the total number of units did reduce by 300 in Fund Y, the amount invested is intact.
Let's say the investor wishes to redeem the investment after 1 year and both the funds provide a 10% return in a year. Therefore, the changed NAVs after a year would be as follows
Fund X NAV = 22
Fund Y NAV = 55
As per the updated NAVs, the returns received respectively after a year, post redemption would be,
Fund X = 22X500 = 11000
Fund Y = 55X200 = 11000
Therefore, it would be safe to clearly conclude from the above computation that NAV is hardly of any relevance. Nonetheless, importance must be given to the fund quality and the overall fund service which makes all the difference; returns are evidently independent of NAV. So, NAV may not be the best limiting factor to assess and finalize an investment in mutual fund schemes.
Another aspect which needs to be considered is the attractiveness of an NFO (New Fund Offer) - newly launched funds that have low NAVs priced at just Rs. 10. This attraction can lead some investors to even switch to NFOs by selling off their existing funds since what they only focus upon is their NAV. This is not advisable at all and it would be pointless to engage in such an activity without enough research. NFOs are not bad per se but it would be beneficial investing in them only if they have something better to offer in return. If done, it would be an ineffective, mindless switch hence it should be avoided.
Last but not the least, let's try and sort the confusion of higher NAVs of direct funds vs. lower NAVs of regular funds. Direct funds do not involve commission to middlemen and are also charged less by the fund managers (expense ratio) which make them quite attractive as far as long term investment is concerned. They are bound to give higher returns in the form of an additional sum saved on commission and investment company fees. Investors must be aware that the switch from regular to direct fund will reduce the number of units without impacting the fund value. The only striking distinction is that a direct fund is directly bought from the mutual fund company without creating the requirement of an intermediary such as a broker, distributor or an advisor. In case of a regular fund, the mutual fund company has to pay some amount as commission to these intermediaries, hence compromising slightly on the returns. If investors are prudent enough to handle their funds on their own, they may go ahead with the direct plans for higher returns else sticking to the regular plans would be an ideal thing to do. Yet again in this case, a major takeaway is that, NAV has no role to play whatsoever. Additionally, book value of funds is not the same as market price of equity shares. This is also a very popular assumption made by investors in general but it is not true. The market price of an equity share has a fluctuating nature as it keeps changing throughout the day, unlike the book value of a fund. Company shares are immensely dynamic and readily influenced by market factors such as demand-supply situation, company's future performance or potential etc. Hence, a comparison of the two is simply out of question.
No matter what the NAV is, a good quality mutual fund scheme will always remain an investment magnet. So, now a smart investor knows what to look at in a mutual fund scheme and is well equipped to make a far better investment choice! Just let go of the NAV. Happy investing!