Low NAV doesn't mean cheaper fund

If there is one myth that fund distributors love to push, it is that a fund with a low net asset value (NAV) is cheaper. "The NAV is just Rs 10" - resounds their sales pitch, and investors flock to the NFO in hopes of seizing this "great deal."

Truth be told, the NAV isn't even to be considered when picking a mutual fund. Let's say that two funds have identical portfolios but different NAVs. One has been around for a while and has a higher NAV than the newly-launched fund. However, as the value of their (identical) holdings increases, the NAV will rise by the same percentage. So, investors in both will make the same returns.

Suggested read: Getting the basics right

Let's look at the numbers. Suppose the NAV of the two funds are Rs 10 and Rs 50, and they rise to Rs 11 and Rs 55, respectively. So it might appear that one has just risen by a rupee while the other by Rs 5, but both have risen by 10 per cent.

Of course, the number of units held would differ. A low NAV would imply a higher number of units and a high NAV would indicate a lower number of units. So let's say you invest Rs 5,000. It would get you 500 units with an NAV of Rs 10 but only 100 units if the NAV is Rs 50 (assuming no entry load).

Yet in both cases, the value of the investment is identical. So Rs 5,000 invested in each would show the same gain. The 500 units (for which you paid Rs 10/unit) would rise to Rs 5,500 at Rs 11 per unit. The 100 units (for which you paid Rs 50/unit) would rise to Rs 5,500 at Rs 55 per unit.

The 'cost' of a scheme in terms of its NAV has nothing to do with returns. What you want to look for in a scheme is its performance, not its NAV.

Suggested read: What causes the difference in NAVs of mutual funds?

The only instance where a higher NAV may adversely affect you is when a dividend has to be received. This happens because a scheme with a higher NAV will result in a fewer number of units. As dividends are paid out on face value, higher NAV will result in lower absolute dividends due to the smaller number of units.

But even here, total returns will remain the same. So, from whichever angle you see it, the NAV makes no difference to returns. Mutual fund schemes have to be judged on their performance. And the simplest way to do this is to compare returns over similar periods.

The confusion over NAV arises simply because investors view a fund's NAV like a stock price. Nothing could be farther from the truth. The current price of a stock could be much lower or higher than its actual value. But the NAV just reflects the current value of the portfolio as it is.

The next time you are evaluating a fund, take a good look at the portfolio and returns over various time periods. Remember, it is the stocks that the fund manager has invested in that determine the returns. The value of the NAV is immaterial.

Also read: Your first mutual fund