A mutual fund’s assets minus its liabilities
In short:
Net asset value (NAV) is the net value of a mutual fund, exchange-traded fund (ETF), or other entity and is calculated by taking total assets minus total liabilities. NAV is extremely important for mutual funds and ETFs as it establishes their value. For mutual funds, the value is used as the set price for which shares of a mutual fund trade at for that day. For ETFs, the value is used as a reference point to identify the need to create or redeem shares of the ETF.
Both mutual funds and ETFs net asset value must be calculated at least once per day and is often represented on a per-share basis, meaning what the net assets of the fund are worth to each share.
Since mutual funds and ETFs are investment vehicles that pool money together from many investors to implement an investment strategy that could include buying stocks, bonds, or other assets. Knowing the NAV of the fund will tell an investor what the value of the underlying investment portfolio is worth.
Key Points
- Net asset value (NAV) is the value of a mutual fund’s or ETFs underlying portfolio after liabilities are subtracted.
- The NAV must be calculated at least once per day usually around 4 pm for both mutual funds and ETFs.
- Mutual funds use NAV as the set price for which shares will trade at that day.
- The assets in the NAV get their value from the trading price of the securities they represent.
FORMULA:
In-depth:
NAV use in Mutual Funds – Structure & Example
Mutual funds are pooled investment funds. This means a money manager or fund operator will go out and collect individual investments from many different investors. The money manager will then take the money and make investments that align with the stated objectives of the fund.
The funds’ objective can and will vary depending on the risk tolerance and returns the investors are looking for. Some funds have an objective of mirroring the S&P 500 or the Nasdaq 100. If this is the case the money manager will go out and invest proportionally invest in the stocks that represent those respective indexes.
Other funds have objectives of producing consistent reliable income for their investors who also have a low risk tolerance. In this case, the fund manager would go out and build a portfolio from government and high-quality corporate bonds.
The objective of the fund will heavily influence the securities that the mutual fund will invest in. These securities, such as stocks, trade throughout the day. Their share price will go up and down all day until the close of trading where the price will “settle” for the day. The accountants working for the fund can then take these prices to calculate the net asset value of the fund, here’s a simple example.
Let’s say a mutual fund wanted to calculate its NAV for the day. They look at all their information and see that the securities in their portfolio are worth $93 million. In addition, they also have $15 million of cash on hand to cover redemption requests or other investment opportunities. The income they received from dividends today was $500,000. Then they look at their liabilities which show $15,000 of accrued expenses, $3 million of short-term, and $10 million of long-term liabilities.
To find the NAV the accountants apply the formula from above.
Total Net Asset Value = ($93,000,000 + $15,000,000 + $500,000) – ($15,000 + $3,000,000 + $10,000,000)
Total Net Asset Value = $95,485,000
Now this mutual fund needs to find the net asset value per share. To do this the accountants then divide the total net asset value by the number of outstanding shares. In this case, the number of outstanding shares is 1 million and the calculation would look like this.
Net Asset Value = $95,485,000 / 1,000,000 shares
Net Asset Value = $95.485
For a mutual fund, this $95.485 is the value of each share of the fund on this day.
Using NAV to Set Share Price
The vast majority of mutual funds available are called open-end mutual funds. This means that they are continuously open to additional capital investments. Since they are always open to additional capital investments they end up trading differently than normal stocks do.
Normal stocks trade on secondary markets which are stock exchanges such as the NYSE or the Nasdaq. In secondary markets, shares trade between other investors without the involvement of the company the shares represent.
Mutual fund shares trade in primary markets meaning shares come directly from the fund itself. When an investor wants to buy shares they buy shares directly from the investment company (mutual fund) itself. Likewise, when an investor wants to sell shares, they sell the shares directly back to the investment company.
This is where NAV comes in. How do you find out what the shares are worth? How are you fair to current investors and don’t dilute their investment?
In order to be fair to current investors and not dilute their investment, you need to ensure the new capital coming in is added proportionally to the investment capital already in the fund. Or another way to say it is that each new $1 invested buys the same amount of underlying shares of the portfolio that a current $1 investment represents. NAV allows the fund to calculate what the portfolio of the fund is worth on a per-share basis and therefore take in new funds without diluting current investors’ interest.
Since NAV is the value of the underlying portfolio per share, this then tells the fund what the shares are worth.
Executing Orders for Mutual Funds
When you place an order to buy shares in a mutual fund the order won’t be filled until the end of the day around 4:00 pm EST when the NAV of the fund is calculated. Mutual fund shares only trade at one price per day.
For example, say you wanted to buy 100 shares of Vanguard 500 Index Fund Admiral Shares (VFIAX) and decided to place your order at 9:45 am. You won’t own the shares, the money won’t be drawn out of your account, and the price you pay won’t occur or be known until after the close around 4:00 pm. At that time the Nav is calculated and your order is executed.
NAV Use in ETFs – Structure
ETFs work a little differently than traditional mutual funds when it comes to NAV which is due to their structure. ETFs unlike traditional mutual funds trade on secondary markets meaning their shares trade continuously all day. This also means that trading of ETF shares occurs between other traders or investors not directly with the fund itself.
Just like traditional mutual funds, ETFs also have a net asset value which tells an investor what the underlying portfolio is worth. The difference is that the shares of an ETF can be out of alignment with the NAV of the fund since the shares trade between other investors and is a product of supply and demand.
When shares of an ETF trade for more than the NAV of the fund is worth this is called trading at a premium. On the other hand, when shares of the ETF are trading for less than the NAV of the fund this is called trading at a discount. Both cases are a result of supply and demand for the share of the ETF and are not a reflection of the underlying portfolio.
In order to ensure that the ETFs shares are trading in line with the NAV of the fund specialized large investors called authorized participants (APs) are involved in creation and redemption. APs will add shares to ETFs when the ETF shares are trading at a premium to increase the supply and restore equilibrium. Likewise, APs will redeem shares when shares are trading at a discount to decrease supply. We cover this process more in-depth in what is an ETF.
What NAV Cannot Tell You
NAV should not be thought of as a quick measure of intrinsic value or indication of the future value of the fund. It is important to remember that mutual funds and ETFs get their value from the many companies their portfolios represent. If the underlying companies in the portfolio are lacking in true value then ultimately the true value of the fund is probably questionable regardless of what the NAV says.
Additionally, the future performance of a fund is highly dependent on the objective of the fund, its style, and the companies or assets it invests in. If a fund invests in high-growth large-cap companies on a diversified basis odds are it will likely perform better than a fund which looks for stable dividend-paying companies since their objectives and what they are investing in are different.
Fees such as the expense ratio and loads can play a large impact on the performance of an investment of a fund. If fees are high, gains from your investment will likely be dampened if the performance of the fund does not justify the fees.
While NAV is an important aspect of mutual fund investing, total information about the fund shouldn’t be ignored and is often just as, if not more, important to take into consideration.
Net Asset Value Frequently Asked Questions
Net Asset Value (NAV) is calculated by taking the total value of all cash and securities in a fund’s portfolio minus its total liabilities. Formula: (total assets – total liabilities) / outstanding shares.
Net asset value (NAV) increases when the total value of the securities in a fund’s portfolio increase.
Net Asset Value and Book Value are not the same in what they are used to reference. Book Value is used to reference the net assets of a company whereas NAV is used to reference the net assets of mutual funds and ETFs.
A mutual fund has $108,500,000 in total assets and $13,015,000 in total liabilities. Its NAV is then $108,500,000 – $13,015,000 = 95,485,000. If the fund has 1 million shares the NAV per share is $95.485.