When it comes to investing in mutual funds, one of the first considerations for investors is the potential returns they can expect. While predicting the average returns on mutual funds with absolute certainty is impossible, understanding how they are computed can provide valuable insight into the performance and suitability of different mutual fund options. Let's explore the types of mutual fund returns and how they are calculated to empower you to make informed investment decisions.
Types of mutual fund returns
Absolute returns
Absolute return measures the simple percentage increase or decrease in the value of your investment without considering the time taken for this change. It is important to note that absolute returns are ideal for investments held for less than one year, as they do not consider the investment's tenure.
Here’s the formula to calculate absolute returns:
Absolute returns = [(Final value - Initial value)/ Initial value
Say you invested Rs 200,000 in a mutual fund scheme. The current market value of your investment is Rs 400,000. In this case, your absolute return would be calculated as:
[(400,000 - 200,000) / 200,000] = 100%.
Annualised returns
Annualised returns, often calculated using Compound Annual Growth Rate (CAGR), help you understand investment growth over a period. CAGR reflects the rate of return on an annually compounded basis and allows you to compare investments with different holding periods.
The formula for CAGR is:
CAGR = [(Current value / Beginning value) ^ (1 / Number of years)] - 1
For example, suppose you invest Rs 80,000 in a mutual fund scheme. Over the course of three years, your investment grows to Rs 1,20,000. Your annualised return would be calculated as:
[(120,000 / 80,000) ^ (1 / 3)] - 1 = 14.47%
Trailing returns
Trailing returns provide insight into a mutual fund's performance over a specific given period, typically one, three, or five years. It takes into account the Net Asset Value (NAV) of a mutual fund scheme to compute its return. Trailing returns are normally used to gauge the recent mutual fund return of a scheme.
The formula for trailing returns is as follows:
Trailing returns = (Current NAV/ Starting NAV) 1/number of years – 1
Total returns
When you invest in mutual funds, your earnings can range from capital gains to dividends and interest. Total returns are the sum of all these earnings. It can be calculated using the following formula:
Total returns = [(Capital gains + Dividend or Interest)/ Total investment] x 100
Rolling returns
Rolling returns assess the annualised average returns of a mutual fund scheme over a specified period, which can be yearly, monthly, weekly, or daily, up to the last day of the selected duration. It is useful for understanding how the fund performs during different market conditions.
Extended Internal Rate of Return (XIRR)
XIRR is a crucial metric that is particularly used in the context of Systematic Investment Plans (SIPs) in mutual funds. SIPs involve investing varying amounts at different intervals, which makes traditional calculations complex and often inaccurate. XIRR computes the CAGR for each SIP.
However, the manual calculation of XIRR can be complex. Microsoft Excel offers a user-friendly solution with its built-in XIRR function. Here’s the formula for the same:
XIRR (Values, Dates, Guess)
Additional Read: What is XIRR in mutual funds, and why is it important?
Conclusion
While the mutual fund return rate serves as a crucial metric for evaluating investment performance and planning, it should not be the sole consideration. It is essential to consider factors such as portfolio diversification, the expertise of the fund manager, expense ratios, etc., in the investment decision-making process.
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MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS. READ ALL SCHEME RELATED DOCUMENTS CAREFULLY
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MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
