Mutual Funds: Net Asset Value Explained

A mutual fund is a type of investment that allows investors to pool their money from different sources and invest it in a collection of different asset classes such as stocks, bonds and other publicly traded securities. Each owner of the individual securities owns a percentage of the total portfolio that is managed by a portfolio manager, who has both the experience and the knowledge to buy and sell the fund’s assets according to the fund’s prospectus.

One of the major advantages of investing in mutual funds is that, unlike stocks whose value may fluctuate sharply during the trading session, mutual funds are priced at the end of each trading session, based on the individual value of the securities in the portfolio. The Net Asset Value (NAV) of a mutual fund is the total market value of the individual assets included in the portfolio, including cash, after deducting any liabilities, divided by the number of shares outstanding. The Net Asset Value is what investors have to pay to buy the mutual fund, plus any fees included. The change in the Net Asset Value is the daily change in the value per share at the end of each trading session.

Example

A mutual fund sells 10 million shares to the public for $10 per share. As already explained, the value of the mutual fund is the value of the portfolio of stocks. Therefore, the value of the mutual fund is 10 million shares x $10 per share = $100 million.

If the market value of the stocks in the portfolio increases to $120 million, after deducting any liabilities, then each share in the portfolio would be worth more than $10. In particular, the Net Asset Value (NAV) formula is:

NAV = (Market Value of Fund – Liabilities) / Shares Outstanding = $120 million / 10 million shares = $12

Therefore, the Net Asset Value of the mutual fund is $12 and this is the value that investors have to pay to buy the fund.

Liabilities may include money borrowed to buy additional securities, management fees and so on. Typically, the amount of liabilities is small compared to the total assets of a mutual fund; however, it has to be deducted before the Net Asset Value is calculated.

A very important consideration for investors is to understand how Net Asset Value differs from stock price. First of all, they differ in their definition. Net Asset Value is the price of the mutual fund share, while stock price is the share price of a company’s stock. However, there are more differences between the Net Asset Value and the stock price:

·         The Net Asset Value is calculated at the end of each trading session. On the contrary, the stock price is subject to all fluctuations and market ups and downs that may occur during the trading session.

·         The Net Asset Value is calculated using the above formula. The stock price is calculated based on several market factors such as the general state of the economy, the company’s fundamentals, the investors’ perceptions about the company, the company’s prospects as well as many psychological factors.

·         The Net Asset Value does not provide investors with an idea about a fund’s performance. For example, a Net Asset Value of $10 is not necessarily a better investment than a Net Asset Value of $5. Besides, when a Net Asset Value declines it may be the result of dividend distribution and not of the mutual fund’s underperformance. On the other hand, a stock price reflects accurately the performance of a company. Therefore, investors should examine more factors when they consider reinvesting their money in a mutual fund, besides the Net Asset Value.