Understanding the Net Asset Value of Your Favorite Funds
As a new investor, you may see the phrase NAV, or net asset value, next to your favorite mutual fund when you go to buy or sell shares. What is the definition of NAV or net asset value and why should you care? It turns out, it matters a lot. In fact, net asset value, along with the dividends you receive from your investment, if any, are the only things that matter to your portfolio's total return in the long-run.
Let's Take a Step Back and Look at How Mutual Funds Are Structured
Mutual funds are a type of pooled trust fund or corporation that invests in other assets such as stocks and bonds (if you want to understand the minutia, you can learn more by reading How Are Mutual Funds Structured?). However, stocks, bonds, and many other securities such as REITs trade throughout day when the markets are open. A smart investor would be able to take advantage of this by buying or selling shares of a mutual fund that hadn't yet reflected a change in the underlying portfolio, giving them an unfair advantage.
To protect investors from rapid market traders, mutual fund shares only trade once a day. This avoids such situations. At 4:30 p.m., Eastern Standard Time, the value of a mutual fund's underlying positions is added up by accounting firms based upon the closing price of the stock market and other exchanges, and used to determine the value of all the mutual fund's holdings.
Any debts or liabilities of the mutual fund, such as stock that is sold short, is deducted to calculate the net asset value, or NAV, as it is often called. The stock exchanges then update the share price of the mutual fund to reflect this new NAV.
Net asset value, or NAV, is really just the net worth or book value (asset - liabilities) of the mutual fund based upon the closing pieces of the underlying investment the fund owners.
It is the price at which investors can buy or sell their shares at the end of each trading day. Mutual fund NAV does not reflect embedded capital gains, which means that under the wrong circumstances, you could have to pay someone else's tax bill even if you experience a loss on your shares.
Any orders that you place to buy or sell mutual fund shares are aggregated and then settled at 4:30 p.m., EST. For example, if you sell 1,000 shares of an index fund at 11:32 a.m., you won't know the price you are going to receive for those shares, or get your money until 4:30 p.m. that afternoon when the NAV is calculated. This is the reason you never see the prices of traditional mutual funds throughout the trading day.
In contrast to traditional mutual funds, exchange-traded funds, or ETFs, trade throughout the day and as a result, the share price might be at a premium, at parity, or at a discount to the NAV. This means you might pay more or less than the value of the underlying securities of the fund itself. Historically, closed-end funds have traded at discounts, in some cases, substantial discounts, to net asset value.
What Net Asset Value Can't Tell You
Net asset value does not account for the sometimes significant unrealized capital gains exposure that has sometimes built up within an older mutual fund or index fund.
Net asset value can't tell you if the actual intrinsic value of the underlying holdings is reasonable or not; e.g., during the dot-com boom, you could have have bought a fund at its net asset value and still been paying obscene price-to-earnings ratios for businesses destined for bankruptcy.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.