Investing in mutual funds can be a confusing journey, especially for those new to the world of finance. Among the myriad of terms and concepts you’ll encounter, one that often confuses many investors is the Net Asset Value, or NAV, of a mutual fund. It’s a number that seems to carry a lot of weight, but is it really as important as it appears?
Understanding the NAV Misconception
The Net Asset Value, NAV, is the per-unit market value of a mutual fund. NAV is derived by summing up the market value of all the securities held within the fund’s portfolio, deducting the associated expenses, and subsequently dividing this figure by the total number of outstanding mutual fund units. It represents the current worth of each unit in the fund, but here’s where the misconception comes in.
High NAV vs Low NAV – Doesn’t Matter
Many investors believe that a fund with a low NAV is a bargain, while one with a high NAV is costly. They enquire about the fund’s NAV before investing or starting a SIP and even buy a peer fund that has a lower NAV believing that will lead to better returns. This misconception is also marketed heavily during NFOs (New Fund Offers) where investors are made to believe that they are getting a steal. It’s only Rs. 10! – This is the main sales pitch!
To put it simply, the NAV doesn’t matter and this metric shouldn’t dictate your investment choices at all. NAV is just a reflection of the value of one unit in the mutual fund’s portfolio.
Let’s illustrate the NAV misconception with an example. Imagine you have 1 lakh to invest, and you come across two mutual funds, Fund A and Fund B, with identical portfolios but different NAVs. Fund A has an NAV of 10, while Fund B’s NAV is 100. If you invest your 1 lakh in either of these funds, you’ll get either 10,000 units of Fund A or 1,000 units of Fund B.
Now, assuming both funds grow by 20% over the course of a year, their NAVs will change. Fund A’s NAV will increase to Rs 12, and Fund B’s NAV will rise to Rs 120. At the end of the year, the value of your investment will be 10,000 * 12 = 1,20,000 for Fund A and 1,000 * 120 = 1,20,000 for Fund B. Your returns are the same, regardless of the NAV!
This example clearly demonstrates that the returns from your investment are independent of the NAV. It’s the performance of the fund and the growth of its underlying assets that truly matter. Two mutual funds, in almost all cases, have a different portfolio, different expenses, and different outstanding units, and hence different NAVs. That doesn’t mean that one with the lower NAV is cheaper.
When you invest in a mutual fund at its NAV, you are essentially buying it at its book value. Whether the NAV is 10 or 100, you are paying the correct price for the assets held by the fund. The NAV reflects the true value of those assets, and when you invest at NAV, you are neither overpaying nor getting a steal.
The only case where NAV could have a detrimental impact is when you’re investing via IDCW or dividend option. This occurs because a fund with a higher NAV translates to a smaller number of units, and since dividends are disbursed based on the face value, a higher NAV leads to fewer units and hence lower dividends. However, it’s crucial to note that despite this, the total return will stay constant.
Choosing the Right Mutual Fund
When selecting a mutual fund, consider your financial goals, risk tolerance, and investment horizon. Are you looking for long-term growth, or do you need a more stable income stream? Are you comfortable with higher risks for the potential of higher rewards, or do you prefer a conservative approach?
It’s also crucial to assess the fund’s expenses compared to peers, historical performance and risk management with respect to peers and the benchmark, and the fund manager’s expertise. While past performance doesn’t guarantee future results, a strong track record can instill confidence in your investment decision and illustrate a well-managed fund.
NAV is a reflection of the per-unit value of a fund’s portfolio and does not dictate the returns you’ll earn from your investment. To make sound investment decisions, focus on a fund’s historical performance, management, risk, risk tolerance, financial goals, and the fund’s expenses.