# What is Absolute Return in Mutual Funds

Explore absolute return in mutual funds and discover how this important metric can help you make informed investment decisions.
Absolute Return
4 mins
17 Feb 2024

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%.

## Importance of Absolute Returns

Absolute returns hold significant importance in investment evaluations due to several reasons:

1. Enhanced portfolio diversification: Absolute returns contribute to building a diversified investment portfolio aimed at achieving better overall returns. By focusing on absolute returns, investors can diversify their investments across various asset classes and securities, reducing the overall risk exposure of their portfolio.
2. Short-term and Long-term potential: Absolute returns cater to investors with different time horizons, offering the potential for both short-term and long-term gains. While some investors seek faster returns in the short term, others opt for a longer investment horizon to maximize their overall returns.
3. Resilience to market volatility: Absolute returns are less susceptible to the fluctuations and volatility of financial markets compared to relative returns. This resilience allows investors to maintain a more stable investment strategy and mitigate the impact of market uncertainties on their investment portfolios.
4. Dynamic risk management: Absolute returns facilitate dynamic risk management strategies, enabling investors to adjust their investment allocations based on changing market conditions and risk profiles. This flexibility empowers investors to make informed decisions to safeguard their investment capital while pursuing attractive returns.
5. Focus on positive returns: The primary objective of absolute returns is to generate positive investment returns irrespective of market conditions. This goal-oriented approach aligns with investors' expectations of achieving growth and preserving the value of their investment capital over time.
6. Simplicity in calculation: Absolute returns offer a straightforward and easy-to-understand method of calculating investment performance. By comparing the initial investment with the final value, investors can quickly assess the absolute return generated by their investment, making it a simple and accessible metric for investment analysis.

## When to use Absolute Return analysis?

Absolute return analysis becomes relevant when investors seek to embrace a certain level of risk in pursuit of the opportunity to attain significant returns, regardless of the timeframe involved.

## 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.

## Is CAGR a Superior Metric to Absolute Returns?

CAGR stands for Compound Annual Growth Rate. It is a financial metric used to calculate the annual growth rate of an investment or asset over a specified period, while accounting for the effect of compounding. CAGR provides a smoothed-out and consistent way to measure the annualized growth rate of an investment, even if it experiences fluctuations in value during the given time frame.

To calculate CAGR, you need two data points: the initial value (usually the investment's starting value) and the final value (its ending value) over the specific period. The formula for CAGR is as follows:

 CAGR = (End Value / Beginning Value) ^1 / n – 1

CAGR is particularly useful when you want to understand the average annual growth rate of an investment over several years, which helps in comparing different investment options and assessing their long-term performance. It provides a more accurate picture of how an investment has grown over time, accounting for the compounding effect, which is crucial in financial planning and decision-making.

When compared to Absolute return in case of mutual funds, CAGR is often considered a superior metric because it factors in compounding. CAGR provides a smoothed-out annualised growth rate, making it easier to compare investments with different time horizons. While absolute return is informative, CAGR gives a more comprehensive view of an investment's performance.

## Concluding Note

Absolute return is a valuable metric for assessing your mutual fund's performance in a straightforward manner. However, when making investment decisions or comparing different funds, consider using CAGR or relative return for a more comprehensive evaluation. Remember that while absolute return provides insight into past performance, it is essential to consider your future financial goals and risk tolerance when investing in mutual funds.

## Calculate your expected investment returns with the help of our investment calculators

What is an annualised return?

An annualised return represents the average yearly gain or loss of an investment over a specified period, typically expressed as a percentage.

Which is better absolute return vs annual return?

The choice between absolute return and annual return depends on investment goals: absolute return focuses on delivering consistent positive returns, while annual return evaluates yearly performance.

What is the full form of CAGR?

CAGR stands for Compound Annual Growth Rate, a measure of the mean annual growth rate of an investment over a specific period.

Which is better, CAGR or absolute return?

The preference between CAGR and absolute return hinges on investment objectives: CAGR offers a smoothed average growth rate, whereas absolute return emphasises consistency.

What is 5-year annualised return?

The 5-year annualised return denotes the average annual return of an investment over a five-year period, providing insights into its performance over a longer duration.

Is annualised return the same as CAGR?

Although similar, annualised return and CAGR differ; while both measure annual growth rates, CAGR factors in compounding effects over time, offering a more precise representation of investment performance.