Investing 101

Mutual funds are priced each 24 hour cycle with what is called Net Asset Value or NAV. Basically, a fancy and highly trusted bean-counter inside the mutual fund company adds up the closing bids for shares at the end of the day – they use “bid” because it’s the price others are willing to buy the stock at that matters; not what someone is asking for them. That price is just the NAV of the fund.

Odd things complicate this process, however. Some mutual funds allocate a given percentage of their total to private investments. In the internet bubble, for example, if you’d made Google a 1% position in your fund and its value in the private market went up a lot – 5x? 100x? - how would you price the NAV of the fund for new investors coming in? There wasn’t a daily private market price for GOOG – it was priced with a valuation done every 3-12 months when some private investor came in and bought shares.

Another odd thing is that mutual funds sometimes have large positions in illiquid stocks. Most funds try to avoid this but odd things happen. They then have to figure out proper “discounting” – that is, if they own $100 million worth of a stock that trades on $20 million a day and they wanted to get out, that stock currently trading at $20 a share will surely go down a LOT if they are trying to sell 5 million shares. So some funds take a “liquidity discount” for those situations. It’s a best guess kind of thing but most funds are terrified of violating any regulations and are generally good about being properly conservative – note that very few mutual funds received the dark scrutiny that many of the other investment vehicles have received in the press during the financial crisis of ‘08 and ‘09…

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