What is net asset value (NAV)?

Just as the value of stocks is based on market capitalization, share price and earnings per share, mutual funds also require a mechanism to set their market value: the net asset value (NAV). 

Read on to understand NAV, why it's essential to ask "What is the net asset value?" and its differences from a fund's market value and limitations.

How net asset value works

What is NAV in stocks? NAV is a way of valuing a mutual fund's portfolio. It considers the current value of the fund's investments plus any liabilities and cash held minus expenses paid for by the fund. The advantage of using net asset value to measure performance is that it considers a mutual fund's assets and liabilities. It provides an up-to-date view of how well a fund has performed compared to its peers. Since it's calculated at the end of each business day, it provides an easy way to get current information about a fund's performance.

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However, since it only looks at market trends during the day or week, it may not be an accurate reflection over longer periods. Also, some underlying factors, such as management fees, are not necessarily reflected in NAV, making it harder to determine a fund's true performance.

A mutual fund or exchange-traded fund (ETF) operates when investors contribute money to the fund. The fund will use this investment capital to buy shares of stock or other securities that fit the fund's objectives (i.e. small cap, aggressive growth, technology, etc.). When you put money into a mutual fund, you're buying shares in proportion to your purchase that you can sell later. This is similar to purchasing stock. However, the difference arises in that a mutual fund makes up a basket of securities, each of which may have a different market value.

Plus, they're traded differently. Stocks trade in real time, and price changes can happen every second. Mutual funds, by contrast, are not traded in real time, but the per-share price of a fund is calculated at the end of each day. Therefore, there has to be some sort of mechanism to set the market price of the fund. This is where NAV comes in. Using the NAV formula, the price of a mutual fund can be set at the end of each business day based on the net assets (total assets – total liabilities) and the number of outstanding shares. 

The NAV formula 

The NAV meaning is a key way to measure the performance of a mutual fund. But just how to calculate the NAV? 

The formula for NAV: Total value of assets – total value of liabilities/total number of outstanding shares

When the value of assets rises, so does NAV and vice versa. In this way, the NAV price is typically very close, if not identical, to a fund’s market price. 

However, other factors affecting the NAV include interest rate changes, bond prices and stock market movements. While these are factors, they're not the only ones. Any changes in the fund’s liabilities or composition can also affect NAV.

NAV and mutual fund valuation

At any given time, the market price of a fund may be different than its NAV. When this happens (i.e., when investors are willing to pay more or less for the fund's holdings), it is referred to as a "premium" or "discount." 

A premium occurs when someone pays more than expected based on calculations, and discounts happen when people spend less than expected based on calculations. Evaluating whether to purchase a mutual fund at its NAV or another value requires analysis of carefully designed factors: portion size offered by the vendor, past performance, management fees, the composition of its portfolio and its estimated return potential from dividends/capital gains. 

Although NAV is a useful tool for evaluating mutual funds, it does have limitations. One limitation is that it only provides a snapshot of the fund's value. The value of the fund's assets and liabilities can fluctuate rapidly, especially in volatile markets. The NAV also doesn't factor in any sales charges or fees associated with mutual funds. These charges can impact the overall return on investment (ROI). Finally, a fund's NAV may not reflect its true market value, especially if it invests in less liquid assets like real estate or private equity.

NAV and ETF valuation 

ETFs are similar to mutual funds in tracking a basket of underlying stocks and/or other securities. Unlike most mutual funds, ETFs trade on public markets like stocks. Their price fluctuates throughout the trading day based on supply and demand for fund shares, just like with any other stock or security. The NAV finance formula calculates an ETF's value. It refers specifically to its net asset value per share, which reflects how much each share is worth at any given moment versus just providing one set figure for all outstanding shares at once, as in the case with mutual funds.

ETFs provide you with the added benefit of transparency. Mutual funds and closed-end funds are not obliged to disclose their daily holdings but rather reveal them only quarterly.

NAV and REIT valuation 

NAV is also used to value real estate investment trusts (REITs). REITs (below) invest in and manage income-producing real estate assets, such as office buildings or shopping malls.

Here, the NAV formula becomes far more complex since it must incorporate market values of all underlying properties owned by the trust. REIT valuation includes income generated by leases, debt assessment based on underlying mortgages, accounting depreciation, taxes, operational expenses such as realtor commissions or advertising costs related to leasing property, special discounts like volume discounts purchased in bulk, etc. 

If you're considering a REIT, carefully examine its holdings for acquisition costs and expected revenues from rent before investing. Just like with mutual funds and ETFs, if you pay more than NAV for a share of a REIT you are buying at a premium, while paying less would be considered buying at a discount.

Example of NAV calculation

But how do you calculate NAV? Let's look at an example of a net asset value calculation.

At the close of trading on July 14, the Technology Select Sector SPDR Fund NYSEARCA: XLK had net assets of $51.04 billion and 287,060,000 outstanding shares.

Its NAV was $177.80, which corresponded closely to its stock price at the close ($175.99) of trading. 

The net asset value formula or NAV formula used to calculate XLK holdings value works out as follows: ($51,040,000,000 - $0)/287,060,000 = $175.99/share, which provides you with an indication as to what each share in this fund should be valued at when taking all underlying factors into account like expenses, dividends, etc. 

However, market prices can fluctuate due to demand and supply dynamics, and a premium or discount could be attached to the NAV.

NAV: One way to calculate value 

However, while the NAV meaning finance is an important metric for evaluating the price of funds and securities, it's not the only factor to consider. Ultimately, focus on the long-term potential of your investments, considering factors like portfolio diversification, risk tolerance and overall financial goals. With careful analysis and a solid investment strategy, you can make informed decisions that help you achieve your long-term financial goals. 

FAQs 

By now, you probably have a firm idea of "What is NAV?" However, we have answers to some other questions we see frequently asked about this concept.