Investing in mutual funds is one of the quickest ways that an investor can earn high returns. In the recent past, the number of individuals who choose mutual funds as their go-to investment instrument has increased drastically. One of the biggest advantages of mutual fund investments apart from high earnings is the fact that the fund is managed by a professional expert. Therefore, investors who do not have much knowledge about the workings of the stock market can invest without having to worry about managing the investment on their own.
One common term that is scattered very frequently in a mutual fund brochure is NAV. NAV is an abbreviation for Net Asset Value and represents the market value per unit in a mutual fund. Unlike the price of stocks in the stock market that change constantly in the same day, the NAV is calculated at the close of every market day. The calculation is made after taking into account the closing price of all the securities in the portfolio of a mutual fund.
The NAV of a mutual fund is computed by taking the current value of the net assets in the fund, subtracting any liabilities, and dividing it by the number of outstanding units. The number of outstanding units refers to the number of units held by all investors in the fund.
Mutual funds are broadly classified into 3 categories based on their structure. They are as follows:
- Open-ended funds: Funds that are bought and sold based on their NAV.
- Close-ended funds: Funds where a fixed number of shares are issued and traded in the stock market.
- Exchange traded funds: Funds that are traded on the stock exchange and whose price is determined by the NAV of the securities.
Significance of NAV on mutual fund performance
The NAV does not play a particularly significant role with regard to close-ended funds since the value of each unit is determined in the secondary market. For open-ended funds, however, the NAV plays an important role in monitoring the fluctuations in the unit value. It should be noted that the NAV is not an accurate indicator of the overall performance of a fund since it is merely the book value of a single unit in a mutual fund. This is very different from the market value of a stock that is traded in the stock market. The concept of a market value does not exist for a mutual fund, which is why they are purchased at book value or NAV.
The NAV has little to no impact on the performance of a fund. The rate of returns from a fund is the most accurate way to gauge the performance of a mutual fund. All mutual funds are required to regularly distribute a significant amount of their returns among its investors. The drop in the NAV occurs primarily when the mutual fund distributes the capital gains. The value of the investment made in the mutual fund stays the same. Perhaps the most accurate indicator of a fund’s performance is the annualised return of the fund across certain intervals.