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What is nav and how is it calculated
Ever wondered what determines the price per unit of your mutual fund or market-linked insurance plan? The answer lies in NAV or Net Asset Value. NAV reflects the per-unit value of an investment product like a mutual fund or insurance unit-linked plan (ULIP). It essentially tells you how much the underlying assets held by the fund or plan are worth at that particular time. Here are details so that you can understand concepts such as NAV meaning and NAV calculation formula. Read on.
What is NAV?
NAV stands for Net Asset Value. It represents the market value of all the securities (stocks, bonds, etc.) held by a mutual fund or ULIP scheme, divided by the number of units outstanding. In simpler terms, it is the price at which you can buy or sell units of the fund.
How Does It Work?
Imagine a ULIP fund that pools money from investors and uses it to buy stocks and bonds. The value of these holdings fluctuates daily. NAV calculation reflects these changes. When the value of the underlying securities goes up, the NAV increases. Conversely, if the value of the holdings falls, the NAV goes down.
How to calculate NAV?
NAV calculation (or formula for calculating NAV) is a straightforward process.
The fund manager calculates the total market value of all the securities in the portfolio at the end of the trading day. They then deduct any liabilities (expenses) from this value. Finally, they divide the resulting net asset value by the total number of outstanding units to arrive at the NAV per unit.
What is the Net Asset Value Formula?
The formula for nav is mathematically expressed as follows:
NAV per unit = (Total Market Value of Assets - Liabilities) / Number of Outstanding Units
This formula provides a snapshot of the fund's intrinsic value per unit on a specific date.
Imagine a ULIP insurance fund with 10,000 units available for investors. They invest in:
- 500 shares of a company at Rs. 100 each (Rs. 50,000 total)
- 200 shares of another company at Rs. 150 each (Rs. 30,000 total)
- 10 bonds of Rs. 1,000 face value each (Rs. 10,000 total)
The fund also has Rs. 1,000 in expenses.
To find the NAV per unit:
- Add the value of the investments: Rs. 50,000 + Rs. 30,000 + Rs. 10,000 = Rs. 90,000 (total market value)
- Subtract expenses: Rs. 90,000 - Rs. 1,000 = Rs. 89,000 (net asset value)
- Divide net asset value by total units: Rs. 89,000 / 10,000 units = Rs. 8.90 per unit
So, the NAV per unit in this example is Rs. 8.90. This means each unit of the ULIP insurance fund is worth Rs. 8.90 based on the current market value of its holdings.
Role of NAV in Fund Performance
NAV plays a crucial role in understanding fund performance.
A rising NAV indicates that the value of the fund's holdings is increasing, potentially signifying positive performance. Conversely, a falling NAV suggests a decrease in the value of the underlying assets.
However, NAV movements alone should not be the sole metric for evaluating a fund's performance. Consider factors like investment goals and risk tolerance before making investment decisions.
Many believe a higher NAV automatically translates to a better fund. This is not true! NAV in mutual fund simply reflects the current value of holdings; a higher number could just mean older funds. Do not be fooled by a low NAV either; it only means you buy more units, not better performance. Remember to track NAV changes over time to understand a fund's true performance.
Illustration – Role of NAV in Fund Performance
Imagine you invest in a Unit Linked Insurance Plan (ULIP) that puts your money into stocks. Let's say the ULIP fund starts by buying shares of various companies for a total value of Rs. 100,000. Now, picture this: over the next month, the stock market does really well, and the value of those same company shares climbs by 10%! This means the overall value of the ULIP fund's holdings also increases by 10%, reaching Rs. 110,000.
Here's where NAV comes in. Since the underlying stocks have increased in value, the NAV of the ULIP fund will also go up by 10%. So, if there were originally 10,000 units outstanding in the ULIP (meaning 10,000 investors like you hold units), the NAV per unit would rise from Rs. 10 (Rs. 100,000 total value / 10,000 units) to Rs. 11 (Rs. 110,000 total value / 10,000 units).
This increase in NAV reflects the positive performance of the underlying stocks held by the ULIP fund. It suggests that your investment has potentially grown in value along with the stock market. However, it is important to remember that NAV is just a snapshot at a specific time. To know your actual return, you would need to consider the NAV at which you entered and exited the ULIP.
How Does an Asset's Net Value Affect Investors?
An asset's net value directly impacts investors. As explained earlier, an appreciating NAV translates to potential capital appreciation for investors holding units in the fund. Conversely, a depreciating NAV might indicate a decrease in the investment's value. However, investors typically redeem or purchase units at the prevailing NAV, and returns are realized upon redemption.
Frequently Asked Question - Net Asset Value
Here are some frequently asked questions about net asset value that can help you understand more about NAV.
What is NAV of a mutual fund?
NAV (Net Asset Value) is the price per unit of a mutual fund or ULIP, showing the market value of the fund’s assets minus liabilities, divided by the number of outstanding units.
What does NAV mean in financial terms?
NAV (Net Asset Value) is defined as the per-unit price of a fund and is calculated by deducting the liabilities of the total market value of all of the assets and dividing that number by the amount of the units. It depicts the price you can either purchase or sell one unit.
What affects the NAV of a mutual fund?
NAV varies with the market value of the holdings of the fund, the income earned during investment, expenses or liability. An increase in underlying assets increases NAV and vice versa.
Is a higher NAV good or bad?
Higher NAV does not always indicate good performance as it is only a reflection of the present value of the fund holdings. The returns should be measured over a period and performance should not be taken by looking at the NAV amount.
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