Do low NAV mutual funds give better return in the long term?

Many investors, particularly those who are just starting, have this notion that mutual funds with low net asset value (NAV) will provide better returns over time. This misconception arises from a wrong interpretation of NAV itself and its implications on the performance of a mutual fund. Therefore, to help investors make wiser moves, it is essential to comprehend the idea behind net asset value and its correlation with the performance of various funds.

What is NAV?

NAV stands for Net Asset Value. The performance of a mutual fund scheme is denoted by its NAV per unit. NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on a given date. For example, if the market value of securities of a mutual fund scheme is ₹200 lakh and the mutual fund has issued 10 lakh units of ₹10 each to the investors, then the NAV per unit of the fund is ₹20 (i.e., ₹200 lakh/10 lakh).

In simple terms, NAV is the price per unit of the mutual fund on any given day. It reflects the market value of all the assets held by the fund after accounting for expenses and liabilities.

The NAV Misconception

Many investors believe that a mutual fund with a lower NAV is cheaper and therefore a better investment. For instance, if two mutual funds have NAVs of ₹10 and ₹50, an investor might assume that the fund with an NAV of ₹10 is more affordable and likely to provide better returns. However, this assumption is incorrect.

NAV is merely a reflection of the fund's total assets divided by its outstanding units. It does not indicate the quality or potential of the fund's investments. The NAV of a mutual fund can be influenced by many factors, such as the market value of the underlying assets, dividends, and changes in the number of units due to new investments or redemptions.

The Role of Fund Management and Portfolio Quality

The true indicators of a mutual fund's potential are the quality of its portfolio and the decisions made by its fund manager. The expertise of the fund manager in selecting assets, timing trades, and managing risk significantly influences the fund's performance. Factors such as the fund's investment strategy, asset allocation, and historical performance are much more relevant to an investor's success than the NAV.

Dividends and NAV

Another common misconception is that higher dividends on a fund with a higher NAV result in more value. Dividends are paid out from the fund's assets, which reduces the NAV accordingly. For example, a 20% dividend on a fund with an NAV of ₹100 and another with an NAV of ₹10 will both reduce the fund's value proportionately. Dividends do not indicate better returns; they are a way of distributing profits to unit holders.

The belief that low NAV mutual funds provide better returns in the long term is a myth. NAV is simply a metric for understanding the per-unit value of a fund's assets at a given time. It does not reflect the quality of the fund's portfolio or its potential for future growth.

Investors should focus on the fund's performance history, the expertise of the fund manager, and how well the fund aligns with their financial goals. Successful investing requires a broader view, considering various factors beyond just the NAV.