Mutual fund returns represent the earnings generated from investing in a mutual fund, including dividends, interest, and capital gains. These returns reflect the fund’s performance over a specific period and are influenced by the underlying assets' market fluctuations and the fund manager's investment decisions.
To determine how to calculate mutual fund return, you can use methods like Absolute Return for total gains, Annualized Return for yearly performance, and Compound Annual Growth Rate (CAGR) for long-term growth. These methods show how returns are calculated in mutual funds, including dividends and capital gains. Calculating the absolute return is straightforward using the formula: (current NAV−beginning NAV) / beginning NAV × 100. Here, NAV stands for Net Asset Value, which represents the market value of each unit of the fund.
In this article, we are going to look at the different ways of calculating mutual fund returns and a few key things you need to keep in mind when performing mutual fund investment calculations.
What is a mutual fund return?
Mutual fund return refers to the profit or loss generated from your investment in a mutual fund over a specific period. This return is expressed as a percentage, reflecting how well the fund’s underlying assets have performed. It provides investors with a clear picture of their investment's growth or decline, offering insight into how effectively the fund is managed.
The return on a mutual fund is typically adjusted for various factors, including fund expenses, such as management fees and administrative costs, as well as dividend distributions. By accounting for these elements, the calculated return provides a more accurate measure of the fund's performance and helps investors understand the net benefit of their investment. This comprehensive view allows investors to assess the true effectiveness of their mutual fund choices and make informed decisions about future investments.
Different ways of calculating mutual fund returns
The performance of mutual fund investments is dependent on various factors. This includes market conditions, the fund’s underlying assets, its investment strategy and its expense ratio. As an investor, it is important to know how to calculate mutual fund returns since it could potentially help you evaluate the overall profitability of the fund. Here are some of the most common ways of calculating mutual fund returns.
1. Absolute returns
Absolute returns represent the total percentage change in the value of your mutual fund investment over a specific period, without considering the time factor. You can use the following formula to determine absolute returns.
Absolute Returns = (Current Net Asset Value - Initial Net Asset Value) ÷ Initial Net Asset Value x 100
2. Annualised returns
Annualised returns measure the average annual rate of return on an investment over a specified time period. Since the method smooths out fluctuations in performance, it is more suitable for calculating mutual fund returns if the holding period exceeds 12 months. You can use the following mutual fund return calculation formula to determine annualised returns.
Annualised Returns = [(1 + Absolute Returns)(365 ÷ holding period in days)] – 1
3. Compound Annual Growth Rate (CAGR)
Compound Annual Growth Rate (CAGR) is one of the most accurate ways to calculate mutual fund returns. It measures the growth of the fund over multiple periods and considers the effect of compounding. CAGR is widely used by investors and fund managers to compare the performance of their fund with that of its peers or the benchmark index. Using the following formula, you can quickly determine the CAGR of a fund.
CAGR = {[(Current Net Asset Value ÷ Initial Net Asset Value)(1 ÷ holding period in years)] - 1} × 100
4. Extended Internal Rate of Return (XIRR)
XIRR is a comprehensive method for calculating mutual fund returns. It takes into account the timing of the various cash inflows and cash outflows to determine the annualised rate of return. This makes the method suitable for determining returns from mutual fund SIP investments. The simplest way to determine the XIRR of a fund is to use the XIRR function in a spreadsheet program such as Microsoft Excel. The function is as follows:
XIRR (values, dates, (guess))
Here, values represent the various cash inflows or cash outflows, including the redemption amount. Dates represent the various dates on which the inflows and outflows happened, including the redemption date. Guess represents the approximate rate of return you expect the fund to generate. It is optional and can be skipped if you are unsure or do not wish to enter any values.
How to compute your SIP mutual funds returns?
To calculate your SIP mutual fund returns, the most commonly used formula is the XIRR (Extended Internal Rate of Return). SIP mutual funds returns work on the below formula:
P [ (1+i)^n-1 ] * (1+i)/i
Where:
- P is the periodic investment amount,
- n is the number of payments,
- i is the periodic interest rate.
So if you invest Rs 2,000 each month for 24 months, where you expect a rate of return at 12% and your i would be 0.01, your amount at maturity or future value would be 2000 x [(1+0.01) ^24 - 1] * (1+0.01)/0.01, which would give you a value of approximately Rs. 54,500.
How does a lump sum formula work?
The lump sum investment formula is used to calculate the future value of a one-time investment in a mutual fund. It helps investors estimate how much their investment will grow over a given period, assuming a constant rate of return. The formula for calculating the future value of a lump sum is:
FV=P×(1+r)nFV = P \times (1 + r)^nFV=P×(1+r)n
Here, P is the principal amount (initial investment), r is the rate of return per period, and n is the number of periods.
For example, if you invest Rs 50,000 in a mutual fund at an annual return of 10% for 5 years, the future value can be calculated as:
FV=50,000×(1+0.10)5FV = 50,000 \times (1 + 0.10)^5FV=50,000×(1+0.10)5
This results in a future value of approximately Rs 80,525. The lump sum formula assumes that the rate of return is consistent throughout the investment period and that the interest compounds.
This method is ideal for those who prefer a one-time investment over systematic periodic contributions like SIPs. It's particularly useful when you have a significant amount to invest upfront, as it allows you to calculate potential gains over time based on compounding interest, offering a clear picture of long-term growth.
Things to consider when calculating mutual fund returns
When calculating mutual fund returns, there are a few factors that you need to consider. Accounting for the below-mentioned factors can help you get a more accurate picture of the fund’s performance.
1. Investment objective
Understanding the investment objective is fundamental in determining how well a mutual fund performs. Whether the objective is long-term capital appreciation, income generation, or a combination of both, it provides clarity on what the fund aims to achieve. The returns should reflect whether the fund is meeting its stated goals.
2. Investment timeframe
Your investment timeframe plays a pivotal role in calculating mutual fund returns. Short-term investments may yield different results compared to long-term holdings, as returns often fluctuate due to market volatility. A longer investment horizon tends to smooth out short-term market fluctuations and provides a clearer picture of the fund’s overall performance.
3. Risk profile of the fund
Each mutual fund comes with its own level of risk, ranging from conservative to aggressive. When calculating returns, it’s important to consider the risk profile. High-risk funds may offer higher returns but with greater volatility, whereas low-risk funds provide more stability with potentially lower returns. Ensure that the fund's risk aligns with your risk tolerance.
4. Historical performance
Looking at the historical performance of a mutual fund can give you insights into how it has performed in different market conditions. While past performance is not a guarantee of future results, consistent historical returns can indicate a well-managed fund.
5. Expense ratio of the fund
The expense ratio represents the annual fee the mutual fund charges its investors to cover management and operational costs. A higher expense ratio can eat into your overall returns, making it a crucial factor to consider. Always compare the expense ratio with similar funds to ensure you’re not overpaying for management.
6. Dividend distributions
If the mutual fund distributes dividends, it affects the overall returns. Dividends can either be reinvested into the fund or paid out to the investor. Reinvesting dividends often leads to compound growth over time, increasing your total returns.
7. Consistency in returns
When evaluating mutual fund returns, consistency is key. A fund that provides steady returns over several years is more reliable than one with erratic performance. Investors should look for consistency in both bullish and bearish market conditions, as this reflects the stability and management quality of the fund.
8. Performance relative to the benchmark index
Lastly, compare the fund’s performance to its benchmark index. A well-performing mutual fund should ideally outperform or closely match the returns of its benchmark. This comparison provides insight into how effectively the fund is managed and whether it is delivering value to investors.
What is the ideal mode of investment for better returns in mutual funds?
Although most investors tend to make lump-sum investments, this may not always be the ideal mode of investment. This is due to the impact of short-term market volatility, which can end up lowering mutual fund returns during adverse market movements.
Investing via a Systematic Investment Plan (SIP), on the other hand, is more ideal. It involves investing a fixed amount regularly in a fund at predefined intervals. When done over an extended period, SIPs average out the cost of investment and significantly reduce the impact of market volatility, potentially leading to higher returns.
How much return is good in a mutual fund?
A good return on a mutual fund typically varies based on the type of fund, market conditions, and your financial goals. For equity mutual funds, an average annual return of 12-15% over the long term is generally considered strong. Debt mutual funds, being less volatile, may offer lower returns, around 6-8% per annum. Balanced or hybrid funds may yield returns between 8-10%, as they combine elements of both equity and debt.
However, it's essential to evaluate returns relative to the risk taken and the performance of the fund's benchmark. A mutual fund consistently outperforming its benchmark index and delivering returns in line with or above market averages is a good indicator of its performance. Keep in mind that the time horizon, consistency in returns, and how well the fund aligns with your investment objectives are key factors in determining whether the returns are satisfactory.
How to invest in mutual funds?
Investing in mutual funds is a great way to grow your wealth over time by pooling your money with other investors in a professionally managed portfolio. Whether you're a beginner or an experienced investor, the process is straightforward and accessible to everyone.
1. Choose the right mutual fund
Start by identifying your financial goals, risk appetite, and investment horizon. Based on this, you can choose from equity, debt, or hybrid funds. Research the fund's past performance, expense ratio, and benchmark to make an informed decision.
2. Select your investment mode
You can either invest a lump sum amount or opt for a Systematic Investment Plan (SIP), where a fixed sum is invested regularly. SIPs are a disciplined way to build wealth gradually, while lump sum investments are ideal for those with larger amounts of idle cash.
3. Complete the KYC process
Before investing, ensure your Know Your Customer (KYC) details are updated. This includes submitting identity and address proof documents online or at your mutual fund provider’s office.
Can there be negative returns on mutual funds?
Yes, mutual funds can generate negative returns, especially in volatile markets. Negative returns occur when the value of the fund's underlying assets declines, resulting in a lower Net Asset Value (NAV). This is more common in equity mutual funds, which are exposed to market risks and fluctuations in stock prices. If the market performs poorly or the fund’s holdings underperform, the value of your investment may decrease, leading to a negative return.
Debt mutual funds can also experience negative returns, particularly during periods of rising interest rates or credit downgrades of securities held in the fund. However, the impact is generally less severe compared to equity funds.
While negative returns may be unsettling, they are usually temporary. It’s important to focus on the long-term performance of the fund and your investment goals. Diversifying your portfolio and aligning your risk tolerance with the right fund can help mitigate these risks over time.
Conclusion
With this, you must have now mastered the art of calculating mutual fund returns. Before you proceed with the calculations, remember to consider factors such as risk, expense ratio and consistency, among others. If you wish to increase the wealth creation potential of your mutual fund, you could also consider making a SIP investment instead of investing a lump sum.
On the Bajaj Mutual Fund Platform, you can find more than 1,000 mutual fund schemes from some of India’s leading Asset Management Companies (AMCs). You can also compare mutual funds with one another on the basis of different metrics, including their returns, enabling you to easily determine the fund that best suits your requirements.
