After understanding the basics of mutual funds, their different types and ways of investing, we are now comfortable to address the elephant in the room, How are mutual funds priced?
For to answer this, we will take a walk through all the required elements to understand how Net Asset Value (NAV) is calculated and what significance it has on dividends and growth funds.
What Is Net Asset Value (NAV)?
The Net Asset Value represents the market value per share for a particular mutual fund. The calculation is done by deducting the liabilities from the total asset value divided by the number of shares.
One has to gather the market value of a portfolio and divide it by the total current fund unit number to determine the price of each fund unit. Simple.
Usually, the unit cost of mutual funds begin with Rs.10 and increase as the asset under the funds grow, or as the liabilities under the fund decreases. Hence, more popular a mutual fund is, the higher is it’s NAV.
The net value of an asset is most commonly used in open-ended funds, since with these investments, the interest and shares do not get traded between shareholders. Hence, NAV provides a reference value which in return helps you in determining which investment to keep or withdraw from, to maintain a healthy portfolio.
What is the Formula for Net Asset Value?
Now, this mathematics equation is pretty simple. You can easily use the formula below –
The Net Value of an Asset = (Total Asset - Total Liabilities)/Total outstanding shares
Yes, we all are now Einstein’s, however, it is critical to input the correct qualifying items under assets and liabilities to get an accurate net value of assets (duh).
What are Assets and Liabilities for Mutual Funds?
Unlike Stocks, Mutual Funds are not traded in real-time. Instead, they are calculated based on the trading method and depends principally on various assets and liabilities. Let’s dive deeper.
The asset section of mutual funds includes the accruing market value of a particular fund’s investments, receivables, cash, cash equivalents and other garnered income. This market value is calculated at the end of each day, based on the closing price of various securities included in the fund’s portfolio.
Now, these funds may include a percentage of capital in the form of liquid assets and cash as well as other items like interest payments, dividends, etc. The sum of these assets referred above or their variants come under the category of Assets.
Liabilities, they include outstanding payments, money owed to the lenders, and other fees and charges that are owed to the associated entities, which are taken into consideration while computing net asset value of mutual funds.
Liabilities also may include foreign liabilities which can include shares for non-residents (NRI), payment pending to foreign conglomerates and certain sale proceedings which are yet to be ousted.
Various other accrued expenses including utilities, staff salaries, operating expenses, distribution, management expenses etc., which are accounted for the fund houses which manage the funds.
Hence, the above is how net asset value is calculated for mutual funds, keeping a tab on the assets and liabilities as of the end of a particular day helps in calculating NAV.
How is the Net Value of an Asset Relevant for you as an Investor?
Most investors think the NAV is similar to the stock price, however, this is not the case. Hence, when people tend to think NAV as a stock price, they would think lower the price, better investments but this would only be false information and hope. Reason being, when we calculate the Share price of the equity, we take into consideration the liquid assets whereas, when we valuate the NAV, both liquid and non-liquid assets are taken into account.
For you, NAV should act as a history checker tool, you can see the past history of the fund how it has performed, since NAV in layman terms represent to a section (a unit) of the whole pie, hence checking the current cost of funds and it’s historic performance gives us a fair idea to analyze for ourselves where to invest.
Hence, knowing how to read the NAV is equally important while deciding the investment and making and informed decision.
How is the NET Value of an Asset Calculated?
We have two types of net asset value calculation. Them being –
- Daily Net Valuation of Assets
All mutual fund investment companies evaluate the total worth of their portfolio daily after the stock market closes at 3.30 pm. The market when reopens the next day, with the closing prices of the previous day. The fund houses accordingly deduct all the expenses to get net valuation of the assets with above mentioned formula.
- General Calculation of the Net Asset Value of Assets
The general net value of assets is the price of it’s equity share and is given by the progressive cost of individual shares. This gives the market value of a particular asset and is subject to change as per market fluctuations.
- You should know NAV, is the calculation of a single unit price for the whole lot of mutual fund.
- It varies with market but due to other factors as well, since we have non-liquid assets along with liquid assets to be taken into consideration as well.
- You should read the NAV to check the current cost of funds and it’s historical performance before deciding to invest in it.