What is Net Asset Value in Mutual Funds and How Is It Calculated?

To understand the meaning of net asset value, you should first keep in mind that all mutual funds in India are bought and sold in the form of units similar to individual shares. The price of each unit of a fund is referred to as NAV or net asset value of the mutual fund. This way, NAV serves as the basis of making mutual fund investments.

Now, as mutual funds invest in multiple stocks and bonds, the value of investments held by the scheme can change on a daily basis. This is why, NAV of mutual funds changes on a daily basis similar to stock prices. However, mutual fund NAV and shares have one key difference. Net Asset Value of a mutual fund scheme is calculated at the end of each day the markets are open, so NAV changes only once in a day. The price of equity shares, on the other hand, changes in real times as shares are traded during market hours.

To understand the impact of changing NAV on mutual fund investments, let’s consider an example. Suppose you plan to invest Rs. 4000 in a scheme with a NAV of Rs. 20.

In this case, you will be able to purchase (4000/20) = 200 mutual fund units. Now, you decide to investment an additional Rs. 4,000 in the scheme a few days later. But, by this time, the NAV of the fund has increased to Rs. 25.

So number of units you will be able to purchase now will be (4000/25) = 160 units. As you can see, even though you invested the same amount in both cases, the number of units you were able to purchase decreased when the NAV increased. So, your average purchase price of mutual fund units increased.

Similarly, if the NAV had decreased at the time of your second investment, you would have been able to purchase more units. This would have decreased the average per unit cost of your mutual fund investment. This impact of changing mutual fund NAV is the cornerstone of the rupee cost averaging which is considered as one of the key benefits of SIP investments.

Before we comprehend how NAV is calculated, it’s imperative that you understand how a mutual fund invests the money it has collected from numerous individual investors. Based on the value of the investments made, mutual fund units are allocated to individual investors. So, the higher the value of the investment, more is the number of units allocated to the investor.

After a mutual fund collects money from multiple investors, the fund manager makes investments in stocks, bonds and other financial instruments based on the investment philosophy of the scheme. This leads to the creation of a portfolio of assets for the mutual fund. The total value of these investments are considered as the total assets of the mutual fund. As the price of individual stocks, bonds and other investments changes, the total assets of the mutual fund also changes.

Both the total number of units distributed to investors by a mutual fund and the total assets of the scheme play a key role in determining the NAV of a mutual fund. However, there is another factor to keep in mind – the liabilities of the mutual fund scheme.

The liabilities of a mutual fund are primarily the costs related to management of the scheme. The Asset Management Company (AMC), which administers the fund, must pay a number of costs that comprise the liabilities for the mutual fund. These costs include administration fees, custodial expenses, distribution and brokerage commissions, marketing budgets, investor education initiative expenses, and much more.

The Net Assets of a mutual fund are obtained after deducting these costs (or liabilities) from the total value of assets i.e. investments held by the scheme. To get a clearer picture of how these 3 factors – total assets, total liabilities and total outstanding units impact the NAV of a fund, let’s take a closer look at the NAV calculation formula.

The formula for calculating NAV of mutual funds is as follows:

NAV = (Total Assets – Total Liabilities) / Total number of outstanding units

Or

NAV = (Net Assets of a Mutual Fund) / Total number of outstanding units

In the above NAV calculation formula, the total number of outstanding units is the sum total of all units distributed by the mutual fund to all its investors. The NAV calculation formula uses the total assets and total liabilities of a mutual fund calculated at the end of each day, so the net asset value of mutual funds only changes once daily.

As you can see from the formula to calculate net asset value, the total value of assets, the total liabilities of a fund and the number of outstanding units are the 3 factors that impact the mutual fund NAV.

So, assuming only 1 of these 3 factors changes, the NAV of a mutual fund will increase when:

• If the value of investments made by the fund increases
• The total liabilities of the mutual fund decreases
• The total number of outstanding units of the scheme decreases

Therefore, if the opposite to the above happens, the NAV of the fund will decrease. An increase in NAV typically indicates good performance by the mutual fund, which leads to higher profits for the investors. While a decrease in NAV indicates poor performance by the fund which potentially can lead to a loss for the investor.

Investors who try to time markets typically want to make lumpsum investments when the NAV of a fund is low and redeem when the NAV of the fund increases. This difference between selling NAV and purchase NAV is expected to maximize the profits from the investment. While this is possible in theory, it is extremely difficult to implement in practice as market movements and changes in mutual fund NAV can be very hard to predict.

So, instead of concentrating on just on a mutual fund's NAV and trying to time markets, investors should instead focus on being systematic with their investments and stay invested in the long term. By making systematic and regular investments such as through a systematic investment plan (SIP), investors can benefit from rupee cost averaging which reduces the impact of changes in NAV on the overall investment. Additionally, by staying invested longer, mutual fund investments especially equity-oriented investments will get more time to grow. This will allow the investor to benefit from the power of compounding to the fullest.

An SIP Calculator can help you estimate the future value of your investments if you are making systematic investments over the long term

There are two key differences between share price and NAV of a mutual fund. The number of shares released by a company is limited, so the demand of the specific stock due to prevailing market sentiments is the primary factor impacting share prices. A mutual fund on the other hand can issue fresh units whenever it receives a new investment, so the previous performance of a mutual funds reflected by the growth of its investments plays the key role in determining the NAV of a mutual fund.

The second difference is the speed at which share prices change versus change in NAV. When stock markets are open, share prices can change in real-time as they are traded. This is not the case with mutual funds.

Mutual Fund NAV is calculated only after conclusion of the business day using the closing price of stocks and bonds the scheme has invested in. So, NAV of a mutual fund can change only once daily.