Don't let NAV mislead you

We all tend to look at the returns of the mutual fund before taking a decision to invest our hard-earned money in it. The returns actually denote the appreciation/depreciation of the NAV (Net Asset Value) of the fund.

Unfortunately, the NAV of the fund is grossly misunderstood. Here we attempt to clear the myth surrounding NAV.

Definition of NAV

NAV, or Net Asset Value, is the aggregate of the market price of all the shares contained in the portfolio, inclusive of cash after deducting the liabilities divided by the sum of units issued. It can also be called as the book value of the unit of the fund.

NAV = sum of the shares in portfolio + cash -- liabilities / sum of units issued

Myth of NAV

Many people tend to think that the fund with low NAV is much cheaper than the NAV of fund with higher NAV. So people tend to think that if a fund has a NAV of Rs 50, it is cheaper than the similar fund with the NAV of Rs 80.

This misconception stems from the fact that most people tend to equate NAV with the market price of the share. As a result, there have been instances when people have redeemed their investments in well-performing funds to invest in NFOs. Even many mutual fund salesmen tend to mislead people by telling them that funds with low NAV are cheaper than those with high NAVs, thus enticing them to invest in the funds that they are selling.

Difference between NAV and market price of the share

In case of the share of the company, its market price is decided by the stock exchange. While deciding the price of the share, the company fundamentals, view of the company's future performance and the demand-supply situation. Due to this, the market price of the share normally differs from its book value.

But in case of a mutual fund, the concept of market value is absent. So when you purchase mutual fund units, you are buying at NAV, which is simply the book value. So it implies you are paying the correct price of the assets. This price could be Rs 50 or Rs 500, but the concept of higher or lower price is non-existent.

Impact of NAV on its returns

While it is commonly believed that funds with lower NAVs will yield better returns, it is not true. For example, take two funds with NAVs of Rs 50 and Rs 100, respectively. You invest Rs 1,000 in both of them. So you get 20 and 10 units, respectively.

Assume both the funds give a return of 50 per cent after one year. The new NAVs of these funds, thus, become Rs 75 and Rs 150, respectively. Now the value of your investment in first fund becomes Rs 1,500 and that in the second fund also becomes Rs 1,500. Hence the returns in both the cases are same, irrespective of the NAV of the fund.

Instead, it the quality of fund that will greatly impact your returns.

NAV of a mutual fund is grossly misunderstood by the investors as well as the mutual fund. Low NAV does not indicate the fund is cheap, nor does it impact the returns in any way. So always remember this when selecting fund for investment. Rather focus on the quality of fund, which will greatly impact your returns.