Before we comprehend how NAV is calculated, it’s imperative that you understand how a mutual fund invests the money it has collected from numerous individual investors. Based on the value of the investments made, mutual fund units are allocated to individual investors. So, the higher the value of the investment, more is the number of units allocated to the investor.
After a mutual fund collects money from multiple investors, the fund manager makes investments in stocks, bonds and other financial instruments based on the investment philosophy of the scheme. This leads to the creation of a portfolio of assets for the mutual fund. The total value of these investments are considered as the total assets of the mutual fund. As the price of individual stocks, bonds and other investments changes, the total assets of the mutual fund also changes.
Both the total number of units distributed to investors by a mutual fund and the total assets of the scheme play a key role in determining the NAV of a mutual fund. However, there is another factor to keep in mind – the liabilities of the mutual fund scheme.
The liabilities of a mutual fund are primarily the costs related to management of the scheme. The Asset Management Company (AMC), which administers the fund, must pay a number of costs that comprise the liabilities for the mutual fund. These costs include administration fees, custodial expenses, distribution and brokerage commissions, marketing budgets, investor education initiative expenses, and much more.
The Net Assets of a mutual fund are obtained after deducting these costs (or liabilities) from the total value of assets i.e. investments held by the scheme. To get a clearer picture of how these 3 factors – total assets, total liabilities and total outstanding units impact the NAV of a fund, let’s take a closer look at the NAV calculation formula.