Why Buying A Mutual Fund For Low NAV Is A Bad Idea

Many investors often believe that a lower Net Asset Value (NAV)—the market price of a fund minus its liabilities—makes it cheaper and more advantageous to buy more units of a mutual fund. However, viewing lower NAV in isolation can be misleading and does not necessarily indicate the performance or overall value of the fund. Here's why investing based solely on a low NAV might not be the best strategy.

To illustrate this misconception, let's consider a simple example:

Imagine you have ₹10,000 to invest in one of two identical mutual fund schemes that have similar portfolios.

• Fund A has an NAV of ₹50. That means you can purchase 200 units of this fund.
• Fund B has an NAV of ₹100, allowing you to buy 100 units.

Now, assume both funds experience a market price appreciation of 10%. The NAV for each fund would change as follows:

• NAV of Fund A rises to ₹55.
• NAV of Fund B increases to ₹110.

Now, let's evaluate the market value of your investments:

• The total market value of your investment in Fund A becomes ₹11,000 (200 units × ₹55).
• The total market value of your investment in Fund B also amounts to ₹11,000 (100 units × ₹110).

This example clearly demonstrates that the returns remain the same for both schemes, even though one has a lower NAV than the other.

While lower NAV might seem appealing, it's crucial to understand that it only becomes relevant when funds offer substantial dividends. Dividends are paid out on a per-unit basis, meaning if you own more units, you may benefit from larger dividend payouts. Therefore, purchasing a fund with a low NAV could be advantageous if that fund consistently distributes significant dividends.

Another critical factor to consider is that if stock prices rise excessively, the value of those stocks may not continue to grow at the same pace. This scenario applies less to mutual fund units, where the NAV can become irrelevant. Thus, focusing solely on NAV can lead you to overlook potential growth in other key areas.

Rather than basing your investment decisions solely on NAV, consider these essential factors:

• Fund Performance: Assess the historical performance of the fund. Look for consistent returns over different market conditions.
• Quality of Investments: Investigate the sectors and the quality of stocks that the fund invests in. Strong, well-managed companies typically yield better long-term results.
• Historic Returns: Review the historical returns of the fund over various timeframes. Consistent growth is a positive indicator.
• Fund Management: Consider the pedigree of the mutual fund company. Established companies with experienced management teams are often more reliable.
• Price-to-Earnings Ratio: Evaluate the fund's earnings potential through its price-to-earnings (P/E) ratio. A lower P/E ratio might suggest the fund is undervalued, while a higher ratio could indicate overvaluation.
• Expense Ratio: Pay attention to the fund's expense ratio, as higher costs can erode your returns over time.
• Exit Load: Understand the exit load, which is the fee charged when redeeming your units. This can affect your overall returns, especially if you plan to exit the fund soon after investing.

While a low NAV might appear attractive at first glance, it should not be the sole basis for your investment decisions. Instead, focus on comprehensive factors that reflect the fund's overall performance and potential.