When investing, one of the key reasons people commit their hard-earned money is to earn returns and ultimately grow their wealth over time. Whether you're saving for a child's education, planning for retirement, or building a safety net for the future, the goal is simple: to make your money work for you. But as straightforward as this might sound, one of the biggest challenges investors face is measuring the true performance of their investments. It can be tricky and complex to understand and requires precise tools and calculations to capture the true value of your investment.
This is where knowing how to measure investment returns becomes essential for making informed financial decisions and maximizing your wealth. Let us understand the 6 different types of returns that you can use to determine the performance of your mutual fund investments.
Types of Mutual Fund Returns
@ ABSOLUTE RETURNS
Absolute return calculates the growth in value from the date of your investment. It is expressed as a percentage and shows how much the investment has grown or depreciated in value, taking only your investment’s initial and current value into consideration.
Absolute returns = [(Current Value of Investment - Initial Value of Investment) / Initial Value of Investment] x 100
why shouldn’t you use absolute returns to gauge your long-term investments?
Let’s assume an investment of Rs. 1,00,000 is made. After five years, the investment value grows up to Rs. 3,00,000. Then, your absolute return earned would stand at 200%.
This shows that absolute returns just give us an idea about how much the investment value has appreciated or depreciated without taking into consideration the tenure or various cash flows in between if any.
Absolute returns would be an accurate method of assessment when it comes to fixed income products that have a defined annual payout or for investments where the holding period is less than one year and not for products that don’t have a pre-defined or fixed return.
Let’s presume you have invested Rs.50,000 in a Fixed Deposit and after 5 years, the value grows out to be Rs.65,000. Similarly, you have invested Rs.50,000 in a debt mutual fund and after 4 years, the value compounds to Rs.62,000.
If you compare the return generated from FD with the Debt mutual fund using absolute returns, FD would look attractive, but the tenure of the investment avenues and cash flows are different. Hence, it is advised not to use absolute returns when it comes to comparing dynamic-return products as they don’t give you the full picture and are also not accurate in determining your return from an investment if the holding period is more than one year.
@ TOTAL RETURNS
Total returns are often used as synonymous with Absolute Returns, but there’s a slight variation when it comes to Total returns as it also takes into account the dividend amount received along with the initial investment while computing returns.
Total Returns = [(Ending Value + Income from Dividends or Interest - Initial Value) Initial Value] x 100
@ ANNUALISED RETURNS
The annualised return measures the amount of growth in the value of your investment on an annual basis. It shows the amount of money that you have earned per annum.
Annualised returns would be a good measure of returns when you keep reinvesting your gains. But it doesn’t consider the factor of investment risk and volatility.
Annualised returns = [(Ending value of Investment / Initial Value of Investment)^1/n - 1) x 100
CAGR (Compound Annual Growth Rate) – The concept of CAGR is straightforward and requires only three inputs: an investment’s beginning value, ending value, and time duration. CAGR considers the assumption that the investment is compounded over time. This can be the best measure for your Lumpsum investments.
XIRR (Extended Internal Rate of Return) - XIRR is a method to calculate returns when multiple transactions are involved. It works best when your cash flows (investments or redemptions) are spread over a period of time. If you’re investing through SIP or redeeming through SWP or lumpsum, XIRR can help you calculate a consolidated return considering all the timing of your returns and withdrawals. XIRR is nothing but an aggregation of various CAGRs.
@ TRAILING RETURNS
Trailing returns are the returns generated over a specific period ending today. Trailing returns measure the performance of a mutual fund for the past specific periods, such as inception-to-date, year-to-date, one-year, three-year, etc. Trailing returns would tell your annualized return over the time duration, anchored to the current date, majorly taking the entry and exit timing into consideration. It gives the investor an idea about whether or not the mutual fund has generated wealth or reduced wealth over the selected tenure.
However, the fund’s performance towards the end of the period considered might have an undue influence on the returns calculated and it also doesn’t take into consideration any fluctuations in the fund value over the period.
For example, if we compare the 1-year trailing return of a fund as of October 19, 2021, right after the market rally, and the trailing return as of, let’s say, April 19, 2022, when the markets were a little volatile and bearish, the one year trailing returns as of October 2021 would look attractive when compared to the returns as of April 2022. This is because the end period that is considered while calculating trailing returns can skew the overall annualized returns for the tenure.
@ ROLLING RETURNS
Rolling returns evaluate the performance of funds over the chosen period. They focus on the holding period instead of the time of entry and exit, as in the case of trailing returns. Let’s say, we want to see the 5-year return performance of a fund over 15 years from 2005 to 2020. To calculate rolling returns, a range of 5-year blocks like 2005-2010, 2006-2011, 2007-2012, and so on would be taken into account. Through rolling returns, several blocks of 3, 5, or 10 years at various intervals can be used to see how a mutual fund performed for that period which would help investors to manage their expectations from the fund.
It measures returns of mutual funds at different points of time, thereby eliminating any bias associated with returns calculated at a particular point in time. The above were some of the widely prevalent measures of mutual fund returns. While returns may be one of the major factors to review before choosing a mutual fund, it cannot be the sole factor based on which you choose your types of mutual fund returns. Past performance might not be an indicator of future returns.
FACTORS TO CONSIDER WHEN DETERMINING MUTUAL FUND RETURNS
When determining mutual fund returns, it’s important to take into account several critical factors to get a complete understanding of a fund’s performance:
Timeframe: Look at returns over both the short and long term to get a holistic view of how the mutual fund has performed.
Benchmark Comparison: Compare the mutual fund’s returns to a relevant benchmark index to see how it has performed in relation to similar investment options.
Risk-Adjusted Returns: Evaluate returns in the context of the risk taken. Funds with higher returns may have taken on more risk, so it’s important to assess if the returns justify the risk involved.
Expense Ratio: Consider the impact of the fund’s expense ratio, as higher fees can reduce your overall returns over time.
Dividends and Distributions: Take into account any dividends or distributions paid by the fund, as these can influence total returns and have tax implications.
Consistency: Look for stable performance across various periods, which can be an indicator of the fund’s reliability and ability to deliver returns over time.
Past Performance: While past returns don’t guarantee future performance, they can provide insight into how well the fund manager has handled market conditions in the past.
Investment Objective: Make sure that the fund’s goals match your own financial objectives, whether you’re focused on growth, income, or a balanced approach.
CALCULATING MUTUAL FUND RETURNS FOR SIP
The returns on SIP investments is usually calculated on the basis of XIRR. The formula to calculate SIP returns is
fv = p x {[(1+r)^n -1] /r) x (1+r)
where,
fv = future value earned upon maturity
p = fixed investment through sip
r = compounded interest rate
n = investment duration
The formula might look simple if we are straight away given the values of all the parameters, but that’s not the case in reality. It involves some time consuming calculations to arrive at the final answer. Thats why we use the SIP Calculator to remove the trouble and challenge of long calculations. The AssetPlus SIP Calculator is the simplest to use providing instant results.
However, it is to be remembered that though calculators are fast, they give only an approximate value because the actual returns generated may be affected by various factors like market conditions, etc and hence may differ.
CALCULATING MUTUAL FUND RETURNS FOR LUMPSUM INVESTMENTS
Lumpsum investment returns are calculated based on the CAGR formula as it is a one time investment. The formula to calculate lumpsum returns is:
A = P (1 + r/n )nt
Where,
A = Amount of Return on the Lumpsum investment
P = Present Value of investment
r = Rate of return
n = Number of times an interest gets compounded in a year
t = Tenure of investment
Similar to the SIP Calculator, the AssetPlus Lumpsum Calculator helps you to easily determine the returns on your lumpsum investments.
USING A MUTUAL FUND RETURNS CALCULATOR
A Mutual Fund Returns Calculator is an online tool that helps investors estimate the future returns of their mutual fund investments based on inputs like investment amount, tenure, and expected rate of return. Using this calculator provides clear insights into potential returns, helps with financial planning, and eliminates the guesswork from investing. The AssetPlus Mutual Funds Return Calculator offers a user-friendly experience, precise calculations, and flexibility for both SIP and lump sum investments. It’s ideal for investors looking to track performance, compare different funds, and plan investments effectively. AssetPlus stands out for its ease of use and reliable projections, making it a valuable tool for smart investing.
KEY TAKEAWAYS:
Absolute Returns show how much your investment has grown over a specific time, without considering how long it took.
Absolute Returns = [(Current Value of Investment - Initial Value of Investment) / Initial Value of Investment] x 100.
Annualized Returns tell you the average yearly growth of your investment over a period of time.
Annualised returns = [(Ending value of Investment / Initial Value of Investment)^1/n - 1) x 100.
CAGR (Compound Annual Growth Rate) shows a smooth yearly growth rate for comparing long-term investments.
CAGR is the same as annualised returns formula.
XIRR (Extended Internal Rate of Return) calculates the overall return for investments with multiple cash flows happening at different times.
Trailing Returns show how a mutual fund has performed over a set time period, like 1 year or 3 years, ending today.
Trailing returns is calculated using the CAGR formula for specific periods.
Rolling Returns look at how a fund has performed over different time frames to give a more consistent view.
Rolling Returns is calculated using the CAGR formula for overlapping periods.
Total Returns include both the profit you made and any income from dividends or interest
Total Returns = [(Ending Value + Income from Dividends or Interest - Initial Value) Initial Value] x 100
The formula for calculating SIP Returns is fv = p x {[(1+r)^n -1] /r) x (1+r)
The formula for calculating Lumpsum Returns is A = P (1 + r/n )nt
CONCLUSION
In conclusion, while understanding and analyzing mutual fund returns is essential, it should not be the only factor in your investment decision. Returns provide valuable insight, but other aspects like risk, expense ratio, and the fund's alignment with your financial goals should also be considered. Moreover, relying solely on past performance can be misleading, as it may not predict future outcomes. It is always to approach and consider the guidance of an expert like a mutual fund distributor.
FAQs
What is the Average Mutual Fund Return Rate?
The average mutual fund return typically ranges from 8% to 12% annually, depending on factors such as the fund's investment strategy, asset class, and overall market conditions. However, returns can vary widely, and past performance is not indicative of future results.
What are returns on mutual funds?
What is the average 10-year return on mutual funds in India?
How much returns can I get from mutual funds?
Is it possible to have negative mutual fund returns?
Are there taxes on returns generated by mutual funds?