When you invest in mutual funds, you are often keen to know how your investment is performing. One way to gauge this is by understanding absolute returns. Absolute return is a straightforward metric that indicates the actual profit or loss generated by your mutual fund investment over a specific period.
What is Absolute Return in Mutual Funds?
Absolute return, in the context of mutual funds, represents the total gain or loss on your investment without considering the time factor. It is expressed as a percentage and gives you a direct insight into your investment's performance.
How does Absolute Return work?
- Calculating Absolute Return: To calculate the absolute return of an investment, you need to subtract the initial investment amount from the final value (including any interest, dividends, or capital gains) and then divide it by the initial investment. The result is expressed as a percentage.
- Independence from Benchmark: Unlike relative returns, which compare an investment's performance to a benchmark index, absolute return evaluates the investment's performance solely based on the actual gains or losses. It doesn't consider whether the market as a whole is up or down.
- Risk Management: Absolute return is often used by investors and fund managers to assess the success of an investment strategy or a fund. It allows them to focus on the specific performance of an asset or portfolio rather than being influenced by market conditions.
- Asset Allocation: It can be a valuable tool for asset allocation in a diversified portfolio. By considering the absolute return of individual assets, investors can make informed decisions about how to balance their investments for the best overall performance.
Absolute Return Formula and Example
Calculating absolute return is quite simple. Let's say you invested Rs. 50,000 in a mutual fund on January 1, and its current value on December 31 is Rs. 60,000. To find the absolute return:
Absolute Return = [(Current Value - Initial Investment) / Initial Investment] * 100
Absolute Return = [(60,000 - 50,000) / 50,000] * 100 = 20%
So, your absolute return for the year is 20%.
Difference Between Absolute Return and Relative Return in Mutual Funds
Absolute return provides the actual gain or loss on your investment, while relative return compares your fund's performance to a benchmark index (Like Nifty). While absolute return is an exact measure, relative return gives you an idea of how well your fund performed compared to its peers or the market.