What is Mutual Fund Return and how to Calculate it?

What is Mutual Fund Return and How to Calculate it?

Investing in mutual funds is an excellent way to build wealth over the long term. Calculating the returns is crucial to effectively evaluating the performance of mutual funds. The returns you earn on your mutual fund are key in aligning your investment goals and assessing the associated risks. 

This article will guide you in understanding mutual fund returns and easy ways to calculate them.

What are Mutual Fund Returns?

Mutual fund returns refer to the gain or loss in investment over a specific period. These mutual fund returns include dividends, interest and capital gains. They can be calculated daily, monthly, quarterly or annually. It gives the investor a measure of the performance of the mutual funds to determine the profitability. 

Why are Mutual Fund Returns Important?

Understanding mutual fund returns helps investors align their financial goals and make informed decisions.

Investment Performance: Mutual fund returns help one evaluate how their investments are performing. Investors can evaluate if the mutual funds are matching their financial goals. Taking a long-term time frame, one can get a more comprehensive view of the mutual fund returns.

Comparison Benchmark: Returns help compare different mutual funds, allowing investors to choose the best-performing options relative to others or the market.

Evaluating Risk Appetite: Mutual fund returns help investors evaluate the risk with each mutual fund return. Many mutual funds give high returns at a high risk. This will help the investor better understand their investment goals and their risk appetite.

Consistent Returns: Mutual fund returns that give consistent returns over time, are more stable and reliable than those with infrequent performance.

Inflation: Mutual fund returns that outweigh inflation will help the investor build their wealth over time.

Compounding Growth: Investors earn through the compounding effect if they consistently re-invest the returns earned. Re-investing returns leads to exponential growth over a long period of time.

Also Read: Things to Know About Loans Against Mutual Funds

Types of Mutual Fund Returns

Absolute Returns: Absolute return refers to the increase or decrease in investment, in terms of percentage. This type of method is used to calculate returns with a tenure of less than one year.

For instance: Consider the current market value of investment is ₹5,00,000 and the investment amount was ₹3,00,000. Absolute Return = [(5,00,000 – 3,00,000)/3,00,000 ]*100 = 66.67%. Thus, the absolute return is 66.67%.

Annualised Returns: Annualised returns as the name suggests, are the growth in the value of investments on an annual basis. Simple Annualised Returns (SAR) are calculated based on, SAR = [(1 + Absolute Rate of Return) ^ (365/number of days)] – 1

For instance, you invested Rs. 2 lakhs in a mutual fund scheme. After five years, your investment grows to Rs. 2.8 lakhs. The absolute return in this case is 40%. However, due to the compounding effect, the annualized return (CAGR) would be approximately 6.96%. This accounts for the gradual growth each year, rather than just the absolute gain. 

Total Returns: Total returns are the actual returns received from the investment including dividends and capital gains.

For Example, you invested Rs. 50,000 in a mutual fund at an NAV of Rs. 25. You purchased 2,000 units.

After one year, the NAV rises to Rs. 28. The value of your investment is now Rs. 56,000 (2,000 units x Rs. 28). So, your capital gain is Rs. 6,000.

During the year, the scheme also declared a dividend of Rs. 1.5 per unit. Your total dividend is Rs. 3,000 (2,000 units x Rs. 1.5 per unit). 

Your overall return = Rs. 6,000 (capital gain) + Rs. 3,000 (dividend) = Rs. 9,000, which makes your total return = 18%.

Trailing Returns: Trailing returns measure the performance of an investment over a specific period, that concludes today. 

For instance, if the current NAV of a mutual fund is Rs.150 and three years ago it was Rs.90: Three-year trailing return = [(150/90) ^ (1/3)] – 1 = 18.3%

Point-to-Point Return: This is the annual return over a specific period that ends today. You will require the start date and end date of the mutual fund scheme to calculate point-to-point returns.

Annual Return: This is the return earned between January 1st and December 31st of the chosen year.

Rolling Return: This is the annualised return over a specific period of time, like a daily, weekly or monthly basis. 

Also Read: A Beginner’s Guide to Investing in India

How to Calculate Mutual Fund Returns?

Mutual fund return = Net Asset Value Appreciation + Dividend Income

The NAV is as:

NAV = (Market value of assets – Liabilities) / No. of units outstanding 

Different Ways of Calculating Mutual Fund Returns

Absolute Returns: 

To calculate Absolute Returns, 

Absolute Returns = [(Current NAV – NAV at purchase) / NAV at purchase] * 100

NAV (Net Asset Value): Price per unit of the mutual fund

If the NAV when you initially invested in the MF was 100 and now stands at 125, as per the formula

Absolute Returns = [(125 – 100)/100] x 100 = 25%

Thus, the Absolute Returns is 25%

Annualised Returns: Considering the investment period is 4 years. Thus, to calculate the annualised returns,

Annualised Returns = Absolute Returns/ Investment Period = 25/4 = 6.25%

Compounded Annual Growth Rate (CAGR):

CAGR = [(Final Investment Value/ Initial Investment Amount)^(1/no. of years invested)] – 1

Example: You bought 1,000 units of a mutual fund at an NAV of 50. After 3 years, the NAV increased to 75. To calculate the Annualized Return:

Annualized Return =  [(75,000/50,000)^(⅓)] – 1 = 14.5%

Extended Internal Rate of Return (XIRR): Extended Internal Rate of Return involves a lot of factors to calculate regular investment

Things to Consider About Mutual Funds Returns

Mutual fund returns are suited for long-term investors who are looking for a low-risk investment option. Returns depend on the investor’s financial goals and their risk appetite. Mentioned below are a few factors that an investor needs to consider about mutual fund returns:

Expense Ratio: The expense ratio is the percentage charged by the mutual fund annually, to manage the investor’s fund. Such high mutual fund charges can potentially eat into your returns and impact them for the long term. 

Track Record: The past performance of a mutual fund will give you insights into how well the mutual fund will perform. While a past record doesn’t influence future returns, it is one of the key indicators of how well a mutual fund will perform.

Dividends & Distribution: Factor in any dividends or distribution earned from mutual funds, since they contribute to mutual fund returns and impact the fund’s tax efficiency.

Direct Plan vs Regular Plan: When considering the type of mutual fund plan, the expense ratio of a direct plan gives higher returns as compared to a regular plan. This is because, in a direct plan, there is no brokerage or commission. 

Time Horizon: As an investor, one should consider how far or close they are, to achieving their financial goal. If you are closer to achieving your financial goal, you should take less risk.

Also Read: What Is SIP Investment – Meaning and How It Works

Conclusion

In your investment journey, it is important to understand and evaluate mutual fund returns as this will help you assess your financial goals and adjust your risk appetite. When selecting a mutual fund, it is important to factor in the mutual fund plan (direct vs regular), track record and expense ratio and other such aspects. This article covers a few formulas to calculate mutual fund returns, however, there are also online mutual fund return calculators available, to make the calculation simpler.