What are Mutual fund NAV common myths

Many investors look at mutual fund NAV in the same way as they look at share prices and therefore they feel that many schemes which have higher NAVs to be more expensive. Though there are a number of similarities between stocks and mutual funds, investors should clearly understand the difference between the two. Let us understand what are mutual funds in India and how they work.

As we know Mutual funds pool money of different investors and invests them in different financial securities like stocks, bonds etc. Each investor in a mutual fund owns units of the fund, which represents a percentage of the holdings of the mutual fund scheme.

Let us understand with the help of an example. Suppose you invest Rs 100,000 in a mutual fund. If the price of a unit of the fund is Rs 10, then the mutual fund house will allot you 10,000 units. If the total money invested in the fund by all the investors is Rs 100 Crores, then each unit (at Rs 10 NAV) will represent 0.000001% of all the stocks the mutual fund has in its holdings. If you have 10,000 units, then your portion of the mutual fund stock holdings will be 0.01%.

The price of a mutual fund scheme unit, also known as the mutual fund NAV, will depend on the value of the underlying securities of the scheme portfolio. The NAV is calculated by dividing the net assets (value of the securities and cash held by the fund minus the liabilities) of the fund by the total number of units outstanding. Say if the net assets of the scheme is 100 Crores and the total units issued to investors are 70 Lakhs, then the NAV of the scheme will be Rs 142.8571 (1,000,000,000 / 7,000,000 = Rs 142.8571).

What is Mutual Fund NAV

Now let us see some common Mutual Fund NAV myths which can lead you to make wrong investment decisions.

  • Schemes with low NAVs are attractive than schemes with high NAVs: You should understand that mutual fund units, unlike stocks, derive their value from the underlying securities of the scheme. Mutual fund schemes are launched at par value (Rs 10) and the current NAV reflects the growth in the asset value since inception. Older schemes will have higher NAVs and newer schemes will have lower NAVs. This does not mean that, older schemes are expensive and newer schemes cheap. A newer scheme may buy richly valued stocks and still have lower NAV compared to an older scheme which buys undervalued stocks.
  • New Fund Offers are cheap because they are available at Rs 10 NAV: As mentioned earlier, the par value of a mutual fund unit is derived from the value of the underlying securities and the accumulated profits since inception of the scheme. Two different mutual fund schemes may have exactly the same portfolio holding and yet one may be offered at par value (NAV of Rs 10) while the NAV of the other scheme might be more than 100; the difference in price notwithstanding the intrinsic value of both the schemes is exactly the same. The annualized growth in the scheme NAV over a period of time is the relevant measure of a mutual fund scheme performance.
  • Investing in schemes which declares regular or big dividends gives higher returns: As per SEBI regulations, dividends can be paid only from the profits made by the scheme. Dividends are adjusted from the NAV of scheme. For example, if the Net Asset Value of a scheme is Rs 50 and the scheme declares a dividend of Rs 4 per unit, the Net Asset Value (ex-dividend) will fall to Rs 46post declaration of the dividend. Dividends are declared at the discretion of the fund manager.

    See the details of top dividend paying mutual fund schemes

  • Booking profits in schemes which give good returns: Mutual fund schemes and stocks are fundamentally different. In direct equity investing, some investors book profits when share prices go up to a certain level. If you follow the same approach in mutual funds, you may end up redeeming funds that have performed well and retain funds which have performed poorly. As discussed earlier, mutual fund NAV growth of different schemes are not indicative of relative valuations. Therefore, investors should select schemes based on its long term performance track record and retain the funds that have performed well over a sufficiently long period of time and redeem funds that have not met your expectations over a period of time. Mutual Fund NAV has nothing to do with this.