How mutual fund NAV per-unit is determined: A guide to costs, NAV, and fees

Mutual funds remain a suitable choice for investors seeking diversification, professional management, and an accessible route to potential wealth creation—be it for a retirement mutual fund plan or intermediate financial goals.

However, behind the simplicity of buying fund units, there’s a complex mechanism that sets each unit’s price daily. Understanding how mutual fund NAV is determined is essential for grasping your fund’s performance, the effect of fees, and the general pricing method that underpins various types of mutual funds.

• Table of contents

1. Mutual funds: Distinct types and their pricing mechanisms
2. Understanding mutual fund costs
3. Grasping the mutual fund expense ratio
4. Exploring additional mutual fund fees
5. Reasons mutual fund fees have fallen
6. What is NAV and how to calculate it
7. Expense ratio in practice: An example
8. Cutting your mutual fund fees: Practical tips
9. How mutual funds distribute dividends

Mutual funds: Distinct types and their pricing mechanisms

Before looking at how mutual fund NAV is determined, let’s define the types of mutual funds:

• Equity funds: Primarily invest in equity and equity related instruments. Price movements reflect fluctuations in the underlying equities.
• Debt funds: Focus on government or corporate bonds, with unit price influenced by interest rate trends and bond valuations.
• Hybrid/balanced funds: Combine equity and debt, often seeking a balance of relative growth and stability.
• Index funds/ETFs: Track a benchmark index. The unit price closely mirrors the index’s daily movement.
• Sectoral/thematic funds: Specialise in particular sectors (technology, finance, etc.), making the fund’s price more sensitive to that sector’s performance.

Regardless of category, a fund’s daily unit price is driven by the Net Asset Value (NAV). Each trading day after markets close, the fund house sums the market value of all assets, subtracts liabilities and expenses, then divides by the total number of units. This figure becomes the published NAV for the next day’s transactions.

Understanding mutual fund costs

Mutual fund costs include multiple components that can affect an investor’s net returns:

• Fund management fees: Compensation for the fund manager’s expertise and research.
• Administrative fees: Cover regulatory filings, record-keeping, and other operational expenses.
• Distribution/marketing charges: These pay for advertising or commissions to distribution channels.
• Other charges: Legal fees, audit costs, or shareholder communication expenses.

Summed together, these elements define what mutual funds fees are. Some costs are transparent; others might be less obvious. By reading a scheme’s Key Information Memorandum (KIM) or Scheme Information Document (SID), you can confirm its maximum permissible charges.

Grasping the mutual fund expense ratio

A key metric summarising most fund costs is the mutual fund expense ratio:

• Definition: Expressed as an annual percentage of the fund’s average net assets. For instance, if a scheme has a 1.5% expense ratio, then Rs. 1.50 is charged yearly for every Rs. 100 invested.
• Coverage: It generally includes management fees, administrative fees, and other operational costs but excludes transaction commissions or entry/exit loads.
• Effect on returns: Over extended periods, even a seemingly small difference in expense ratio—like 0.5% vs. 1.5%—can compound to a significant gap in total returns.

Equity-oriented funds, especially actively managed ones, often have higher ratios than debt or index funds. Still, investors need to balance cost with a manager’s track record, acknowledging that lower fees do not automatically guarantee top performance.

Exploring additional mutual fund fees

Beyond the expense ratio, other charges may apply:

• Entry loads: Historically deducted from your initial investment. In India, these have mostly been abolished, so you seldom see new funds impose entry loads.
• Exit loads: A small percentage fee if you redeem units before a stipulated duration—say 1% if sold within one year.
• Switch/transaction fees: Some AMCs levy charges for switching from one scheme to another or for frequent transactions.
• Performance fees (rare in India): In certain specialised or alternative mutual fund structures, a portion of returns above a benchmark might be shared with the manager.

Understanding what is mutual funds fees in total can help you gauge the real cost of ownership and whether a fund aligns with your investment horizon and style.

Reasons mutual fund fees have fallen

Over time, mutual fund fees have seen a broad downward trend:

• Competitive pressures: As more AMCs enter the market, competition compels them to reduce fees to attract cost-savvy investors.
• Regulatory policies: Authorities like SEBI in India set upper limits on expense ratios, forcing fund houses to keep them within permissible bands.
• Market maturity: Greater awareness of index and passively managed funds leads investors toward cheaper products, spurring cost reductions even in active funds.

Beyond competition, reasons for fee declines include:

• Economies of scale: Larger asset bases allow AMCs to dilute overhead costs across more assets under management (AUM), letting them charge less on a per-unit basis.
• Passive investing boom: The popularity of index funds and ETFs has forced actively managed funds to justify higher costs or cut them to retain customers.
• Transparency and technology: Online platforms have streamlined distribution, cutting marketing costs. The investor, in turn, benefits from these operational efficiencies.

What is NAV and how to calculate it

What is NAV? Net Asset Value (NAV) represents each unit’s per-share value. Calculating how mutual fund NAV is determined essentially revolves around:

NAV = (Total Assets - Total Liabilities) / (Number of Outstanding Units)

Assets primarily reflect the market value of stocks, bonds, or other holdings at day’s end. Liabilities can be accrued fees or any short-term debts. Once net assets are known, dividing by the total units yields the daily NAV.

Expense ratio in practice: An example

Imagine an equity scheme with Rs. 1,000 crore under management, charging an expense ratio of 2%. Each year, around Rs. 20 crore goes to cover operational costs. For an individual holding Rs. 1 lakh in that scheme, roughly Rs. 2,000 annually covers fees. If the fund’s raw returns over a year were 12%, the net gain might drop closer to 10% once expenses are accounted for. This gap underscores why expense ratio vigilance is crucial.

Cutting your mutual fund fees: Practical tips

• Opt for direct plans: Offered by AMCs, direct plans exclude distributor commissions, yielding a lower expense ratio than regular plans.
• Consider passive funds: Index funds typically feature smaller fees, particularly suitable for broad market exposure or a retirement mutual fund plan.
• Negotiate or explore online platforms: Tech-driven solutions can slash distribution overheads and pass the benefit to you.
• Stay informed: Regularly review your scheme’s expense ratio, especially if the fund underperforms its category over multiple quarters.
• Watch for exit loads: If you must sell quickly, choose funds with minimal or no exit load to avoid losing part of your gains.

How mutual funds distribute dividends

Many funds reinvest earnings, boosting the NAV. Some, however, pay-Income Distribution cum Capital Withdrawal(IDCW):

• Sources: IDCW come from interest, dividend income on the underlying assets, or realised capital gains.
• Frequency: Can be daily, weekly, monthly, quarterly, or annually, subject to the AMC’s policy and cash flow.
• Impact on NAV: Post-IDCW payout, the NAV drops by roughly the same amount because some portion of the fund’s net assets is distributed rather than reinvested.

For investors wanting steady interim cash flows, IDCW options can help. Still, those aiming for growth might pick growth plans that accumulate returns in the NAV.

Conclusion

A mutual fund’s daily share price might seem abstract, yet it follows a defined method anchored by the Net Asset Value. Additionally, mutual fund cost remains a prime factor influencing net returns, encompassing expense ratios, administrative fees, and loads. Thankfully, market competition, economies of scale, and regulatory oversight have driven down overall fund costs in recent years. By grasping mutual fund expense ratio logic, scrutinising additional levies, and leveraging direct plans or passive funds, you can preserve more of your returns—vital if you’re saving for long-term goals like a retirement mutual fund plan.

Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.