Don’t worry. I’ll explain everything here.
Think of mutual funds like petrol.
Except, petrol, you burn off. Mutual funds, you cannot burn off (thankfully).
Okay, let me explain this more elaborately.
Mutual Fund Units: Like Buying Petrol
You buy 10 liters of petrol. And it costs you Rs 75 per liter.
So you spent a total of Rs 750 on petrol.
And you keep this petrol with you. You store it somewhere in your house (don’t actually store petrol in your house – it is dangerous.)
Now, let us assume after a few days, petrol prices rise. Say it is Rs 76 per liter now.
Now the petrol you had stored can be sold for Rs 760. A profit of Rs 10.
This is exactly how mutual fund units work.
When you invest, you are buying units of a mutual fund.
When you redeem/withdraw money from a mutual fund, you are selling units.
The NAV is the price of 1 unit of a mutual fund. And it goes up and down depending on the market condition.
Don’t worry. The ups and downs are a part of mutual fund investment. People who choose good quality mutual funds made a lot of money over a long term.
6 facts that will make you understand units completely
1. You do not need to buy 1 entire unit
When you buy petrol, you do not need to buy 2 liters or 45 liters (whole numbers) only.
You can also buy 2.34 liters or 45.8 liters, and so on. You can buy in fractions also.
Likewise, with mutual funds, you can buy units in fractions.
You can buy 5.2 units, 311.45 units and so on.
2. You do not need to sell all your units to withdraw
You can partially sell your units also.
If you have a total of 1000 units of a mutual fund, you can partially sell too.
If you need 300 units worth of money, you can sell only that much. The rest can remain invested.
3. You do not need to pay attention to units
For all practical purposes, you really do not need to pay attention to the units. Whether you are buying or selling, it doesn’t make much of a difference.
When you invest, you invest a certain amount. It grows. You track its returns.
When you feel like selling, you redeem whatever amount you wish to.
At no point during the entire process do you have to enter the number of units you want to buy or sell.
4. Units are not the same as share price
It might seem to you that mutual fund units are like share price. That’s true. But only partially.
I strongly suggest you not compare the two.
Share prices fall and rise based on their demand. Such does not happen to mutual fund units.
So for understanding easily, I suggest you do not compare mutual fund units and share price. They are different.
5. Units take some time
When you invest, mutual fund units are allocated in about 3-4 working days.
And similarly, when you withdraw money from mutual funds, the units are sold in about 3-4 working days.
In certain types of mutual funds, this buying and selling of mutual funds happen much faster. Like for example liquid funds. But in most types of mutual funds, it takes 3-4 working days.
6. NAV is the price of each unit
The price of each unit of a mutual fund is the NAV.
If you want to buy 1 unit of a mutual fund, the price you have to pay is the NAV of that mutual fund’s unit on that day.
The NAV changes every day. So when the NAV goes up, you gain.
7. Mutual fund unit price (NAV) goes up and down
Yes, but this is partially true.
If you look at the NAV values of debt funds, they are very stable. They do not show much downward movement.
Equity mutual funds are the ones that move up and down. Even so, if you look at the performance of good equity mutual funds over a long period of time, you will notice that they have risen to spectacular levels.
How mutual fund units are calculated
“Start investing in mutual funds with just Rs 500”.
Sounds familiar? I am sure you have heard this. So what’s happening here?
You are basically buying units of a mutual fund worth Rs 500 that day.
Let us say you want to invest in mutual fund ABC. The NAV of mutual fund ABC on that day is Rs 27.
So how many units will you get?
Price you are paying ÷ NAV = Number of units you get
Rs 500 ÷ Rs 27 = 18.52 units
Now, you have 18.52 units of mutual fund ABC. You spent Rs 500 to buy it. On the day you bought it, its price was Rs 27.
As I said earlier, the NAV of mutual fund ABC (price of 1 unit of a mutual fund) changes every day.
After 2 years or so, you want some money. So you look at your mutual fund investment.
You still have exactly 18.52 units of mutual fund ABC. But now, this NAV of mutual fund ABC is Rs 45.
So you had invested Rs 500. But now, how much is it worth?
Number of units X latest NAV = Present-day worth
Rs 45 X 18.52 units = Rs 833.4
See how simple this is?
Now, let’s say you don’t want Rs 833.4. Your requirement is only Rs 200.
You simply sell the units worth Rs 200.
Amount to redeem ÷ latest NAV = Units you need to sell.
Rs 200 ÷ Rs 45 = 4.44 units.
You need to sell 4.44 units to get Rs 200 based on today’s NAV.
Every time you invest in mutual funds, you are buying units of that mutual fund.
Every time you redeem or withdraw money from mutual funds, you are selling units of that mutual fund.
Allotment of Units
You get your mutual fund units 3-4 working days after the day your purchase.
So which NAV is applicable to you?
NAV cut-off time – If you are buying/selling liquid mutual funds
In the case of liquid funds, if you buy/sell before 2 pm, the NAV value at the end of the present day is taken.
However, if you buy/sell after 2 pm, the NAV value at the end of the next working day is taken.
NAV cut-off time – If you are buying/selling equity and debt mutual funds
In the case of other debt funds and equity funds, if you buy/sell before 3 pm, the NAV value at the end of the present day is taken.
And, if you buy/sell after 3 pm, the NAV value at the end of the next working day is taken.
Mutual fund units when investing via SIP
In SIP, you invest every month on a fixed date.
Every time your SIP amount is deducted, units get alotted based on your SIP amount and the NAV value on the date of investment.
We know that the value of NAV varies from time to time. So you won’t get the same number of units every month.
In the times when the mutual fund is doing well, the NAV will be higher. Hence, you will get fewer units. In the times when the mutual fund is doing poorly, the NAV will be lower. So you will get a higher number of units.
In fact, this is what makes SIP such a great tool. Over a period of time, the price you pay for each unit of the mutual fund is averaged. So you do not pay a very high price for your mutual fund units. This is called cost averaging.
Should I wait for unit prices (NAV) to fall?
Given the above knowledge, a question that might be coming to your mind is: should you wait for the unit prices to fall to lower levels? Which also means, should you wait for the NAV to be lower?
Do you know what you are trying to do here?
You are hoping to time the market.
But what if the price never falls? What if the price continues to climb upward?
Or, what if the opposite happens? What if you invest and the price continues to fall down? You would lose, right?
Here’s the deal with timing the market: do not do it.
Some of the smartest brains in the world have tried to do it. And they have not been very successful at it. It is impossibly hard to time the market.
So instead, I suggest you simply invest. And invest for the long term. In fact, this is what makes SIP such a great investment tool.
Invest regularly. Invest for the long term.
If there’s anything I need to leave you with here, it is this: you do not need to pay much attention to the units of a mutual fund.
During the course investment, you will never be asked to mention the number of units you wish to purchase. You will also never be asked the number of units you want to sell.
But, as an informed investor, you should know this: whenever you invest in mutual funds, you are buying units at present-day NAV; and whenever you’re withdrawing from mutual funds, you are selling units at present-day NAV.
Disclaimer: the views expressed here are of the author and do not reflect those of Groww.