The NAV myth

A friend showed me two funds last week and asked which was the better buy. One had a NAV of Rs 10. The other Rs 480. He was leaning hard toward the Rs 10 one. It felt cheap. More room to run.

I asked him what he thought the Rs 10 was actually the price of.

Here is the math that settled it. Put Rs 10,000 into the Rs 10 fund and you get 1000 units. Put the same Rs 10,000 into the Rs 500 fund and you get 20 units. Now say both funds hold the exact same portfolio and it rises 10 pct. The first is worth Rs 11,000. The second is worth Rs 11,000. To the rupee.

A NAV is not a share price. It is today's value of one unit of the pot. A low NAV does not buy you more, it slices the same money into more units. You own the same rupees of the same holdings either way. Rs 10 is not a discount. Rs 500 is not expensive.

And the cheap sticker hides the thing that actually matters. A new fund priced at Rs 10 has no track record. No drawdown you have watched it sit through. No rule you have seen behave through a bad year. An older fund at a high NAV is not dearer, it has simply been compounding long enough to hand you years of evidence. That evidence is the part worth paying attention to.

The Rs 10 sticker is the easiest thing to see and the least useful. Buy the kitchen's record, not the price of the slice.

What a NAV actually is

The friend's instinct comes from stocks, where people (wrongly, even there) read a low share price as cheap. A fund unit is simpler than a share. There is no order book, no buyer on the other side, no premium for popularity. The fund takes everything it owns at the day's closing prices, adds cash and income due, subtracts what it owes, including the expenses it has accrued, and divides by the number of units outstanding. That is the NAV. It is a division, struck once a day, and every investor who comes in or goes out that day does so at the same number.

Since a unit is just a slice, the number of slices tells you nothing about the size of the pie. Picture the same Rs 10,000 cut two ways.

Change the numbers yourself. Put in any two NAVs; the end values match as long as the portfolio return is the same.

How the day's NAV is struck

The mechanics also explain why nobody can buy a unit at a "low" moment within the day. SEBI's rule since 1 Feb 2021 (circular of 31 Dec 2020, as explained by AMFI) is that a purchase gets the NAV of the day on which your money is realised in the fund's account before the cut-off, 3 pm for most schemes, whatever the amount. Money that arrives later gets a later day's NAV.

1. Market closesEvery holding is valued at the day's closing price.
2. Net it offAdd cash and income due; subtract liabilities and the day's accrued expenses.
3. DivideNet assets divided by units outstanding is the NAV.
4. Price the day's ordersMoney realised before the cut-off gets that NAV; later money gets the next one.

Two everyday events move a NAV without changing your wealth. A payout under an income distribution option lowers the NAV by the amount paid out, because that money has left the pot and landed in your bank account. And a fund's expenses come out daily before the NAV is struck, which is the one place the NAV does tell you about cost: quietly, by growing slower.

What to compare instead

If the NAV is the least useful number on a fund page, here is what I look at, in the order I look at it. What the fund holds, and how much of that I already own elsewhere. How it behaved through a bad stretch, with the worst fall written down. And what it costs every year, because that is the only difference between two funds that is certain to compound against you.

That last one is worth seeing in rupees. Two funds earn the same 12 percent a year before costs on Rs 10 lakh for 20 years. One charges 0.5 percent a year, the other 1.5 percent.

Neither fund's NAV would have told you that. A NAV of Rs 10 or Rs 500 on day one changes nothing in this sum; the fee changes Rs 14.5 lakh of it. The free expense ratio calculator runs the same comparison with your own figures.

The free Learn module on mutual funds covers how a fund is structured, how the NAV is calculated and what the expense ratio includes, with a short quiz at the end. Two posts go further on the same habit of reading past the front page: why a star rating is a rear view mirror, and why fund size can bloat a strategy that worked when it was small.