Investing is done with the intention of making money. In other words, we invest to earn a return. To know how much return we earned on an investment, we need to know how to calculate it. The simplest form of calculating return is to divide your profit with cost. Take for example, the cost is Rs 80 and selling price is Rs 100. The return is 25% ((100-80)/80). However, in mutual funds, different types of returns are used for assessing a fund. This article covers different types of mutual fund returns and their calculation in detail.
This is the simplest form of return to calculate. It tells by how much your mutual fund investment has grown irrespective of the investment tenure. We use absolute return in our day to day lives. Let’s understand this with an example. Assume you have invested Rs 10,000 in a mutual fund, and after five years, its value increases to Rs 45,000. The capital gain here is Rs 35,000 (Rs 45,000-Rs 10,000).
Absolute return = ((Final value – initial investment)/(Initial investment))*100
The absolute return from your mutual fund investment is 350%. Even if the tenure is seven years instead of five, the absolute return will remain unchanged at 350%. Hence absolute returns are therefore used only for less than one year.
Though easy to calculate, one drawback of absolute returns is that it gets difficult to compare absolute returns of two funds. Hence investors use annualized returns instead, as it gets easy to compare returns of different funds.
Annualised return or compounded annual growth rate (CAGR) is the average return you will earn on your mutual fund investment annually. This return gives a snapshot of a fund’s performance over a period of time, making it easy to compare with other funds.
Annualized return = ((1+absolute return)^(1/n))-1
where n is the number of years.
In the above example, the annualised return for five years is 35.1%. This means the fund gave, on an average, a 35.1% return for five years.
It is very unlikely for a mutual fund to give the same return every year. Sometimes the return can be 40% or even 30%. The drawback of annualised return or CAGR is that it doesn’t give an indication of volatility.
The actual return you make from an investment is the total return. This considers the capital gains, dividends and interest you earn from your mutual fund investment.
Total return = ((Capital gains + dividend + interest)/(initial investment))*100
In the above example, let’s say apart from a capital gain of Rs 35,000, you receive a dividend of Rs 1,000. Then the total return of your investment is 360%.
Similar to absolute return, you cannot compare a fund’s total return with another. Moreover, it assumes that the dividend is reinvested immediately at no additional cost. However, it will give a true picture of the actual return you will get after selling the fund.
The return your mutual fund earns between two time periods is a point-to-point return. To calculate the point-to-point return, you need a start and end date and the fund’s net asset value (NAV) for these dates.
Note: NAV of a mutual fund is its unit price. In other words, it is the price at which mutual funds are bought and sold.
Once these are determined, the point-to-point return can be calculated using the absolute return formula.
Point to point return = ((NAV of the fund at end date – NAV of the fund at start date)/ (NAV of the fund at start date))*100Let’s assume, for example, the NAV of a large cap mutual fund on 1st January 2020 is Rs 15. The NAV increased to Rs 20 on 31st December 2020 and Rs 30 on 31st December 2021. The point-to-point return of the mutual fund for these two dates is 33.3% and 100%, respectively.
Annual return is the return your mutual fund investment earns in one year. Investors usually check the annual return of a fund before making any investing decisions.
Annual return = ((Value of the fund at the end of the year – the value of the fund at the beginning of the year)/ (value of the fund at the beginning of the year))*100
Though the annual return is calculated similarly to the absolute return, it only shows the return from an investment in one year. Hence it can be used to compare returns from different funds in that year. From the above example of the large-cap mutual fund, the annual return of the fund from 1st January 2020 to 31st December 2020 is 33% ((20-15)/15), and from 1st January 2021 to 31st December 2021 is 50% ((30-20/20)).
Returns of a mutual fund over a period of time until today are trailing return. It takes into account the movement of the NAV over a period of time and not just the initial and final investment value. Trailing returns can be for any period of time, such as one month, two months, six months, one year or even five years.
Calculating trailing return is a tedious task, and hence to save time, it is often calculated in Microsoft Excel, Apple Number, or Goole Sheets..
With the trailing return, we can analyse the fund’s performance over different periods and know exactly when it performed well and didn’t.
Rolling return is the average annualised return of a fund for a given time frame. It gives a more accurate picture of the fund’s performance over a given period. With rolling returns, it is easy to identify a fund’s stronger and poorer performance over a given period.
Rolling returns are a true indicator of a fund’s historic performance and are not biased towards the latest returns.
Manual calculation of rolling returns can be quite a task. Hence, investors and analysts use Microsoft Excel, or Apple Number to determine the rolling returns of a fund.
Mutual fund investments are often made in two modes – lumpsum and systematic investment plan (SIP). While all the above returns are used to estimate lumpsum mutual fund returns, SIP returns can be estimated using XIRR.
XIRR measures the return from a mutual fund investment when there are multiple transactions involved at different periods. It considers all the investments and redemptions and gives a single rate of return, which is the investor’s actual return on investment.
XIRR can be calculated using Microsoft Excel, Apple Number or Google Sheets using the XIRR function. You need to know the value and date of investment or redemption along with the current value of the investment to calculate this return.
Mutual funds invest in equity and debt securities, and their returns are tied to market conditions. They do not guarantee any returns. Several types of risk are involved in mutual funds, including market risk, default risk and credit risk.
There are several categories of mutual funds ranging from high risk to low risk, and investors with different risk appetites have a wide choice.
Let’s see how mutual fund returns vary based on risk.
Funds with high exposure to equities are high-risk funds. Typically, investors with a very high risk appetite invest in these funds. These funds have the potential to give market-beating returns. But it is important to note that with high returns comes high risk. Some of the high-risk fund categories are small-cap funds, mid-cap funds, and large and mid-cap funds.
Funds with moderate exposure to equities are moderate risk funds. Investors who have slightly low risk appetite invest in these funds. These funds give slightly lower returns than high-risk funds. But they also have lower risk than high-risk funds. Some moderate risk fund categories are equity savings funds, dynamic asset allocation funds, and credit risk funds.
Funds with low or no exposure to equities are low-risk funds. Investors who do not want to be exposed to market volatility and have no appetite to digest risk, invest in these funds.. These funds have the lowest return and risk when compared to other categories. Some low-risk fund categories are conservative hybrid funds, money market funds, low-duration funds, and liquid funds.
Funds with the highest equity exposure have a high potential to perform well in favourable market conditions. Experts believe that small-cap funds, mid-cap funds, and large-cap funds tend to give good returns in the long term due to their high equity exposure. However, it is important to note that these funds come with a considerable amount of risk. Investors who can stomach high risk can invest in them.
Mutual fund return rates depend on the category of mutual funds. The average return from mutual funds in favourable market conditions varies from 5-15%, depending on the funds’ category. Historically, funds with high equity exposure have given close to 28% per annum in favourable market conditions. However, during unfavourable market conditions, the risk of losing principal is high too.
Yes, mutual funds are one of the best avenues for investment. They invest in equity and debt securities and have the potential to give good returns, provided you invest in the right fund. The right fund is the one that aligns with your investment goals, horizon, and risk tolerance level. You must also check the fund’s returns and portfolio, among other factors, to select the right fund for investment.
Yes, mutual funds are market-linked securities, and their returns depend on the market conditions. You are likely to lose the principal amount if the market is undergoing a correction. If you invest in debt funds, there is always a risk of default. However, they are safer than direct equity and debt instruments as experienced professionals manage them.
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