Mutual Fund Returns

Based on historical analysis, mutual funds have provided solid returns, often around 9 – 12% annually. However, these returns can be higher depending on market conditions. For example, in India, mutual funds have given an average 20% return over ten years and have shown strong market growth. Whereas, in the U.S., mutual funds focusing on large companies have delivered an average annual return of 14.7% over the past decade.

Moreover, in the first half of 2024, equity mutual funds in India delivered an impressive average return of 17.67%. They have showcased their ability to generate significant returns in a short time. Particularly, mid-cap mutual funds performed exceptionally well, with some funds providing returns of over 30%. This indicates that investing in mid-cap funds can be a good strategy for capturing high-growth opportunities in a booming market.

Investing in mutual funds has become a popular choice for many Indians looking for ways to grow their wealth. One of the key factors that investors consider when choosing a mutual fund is its returns. This article will explain what mutual fund returns are, the different types of returns, how to calculate them, and the factors that can affect them.

Understanding returns from mutual funds

When assessing the performance of a mutual fund scheme, solely focusing on its returns can be misleading. While a scheme might have delivered a 10% annualised return over recent years, it is essential to consider the broader market context. If market indices have experienced similar growth during that period, it may not indicate exceptional performance. The true test of a scheme's worth comes during market downturns when its NAV falls more than its benchmark. This underperformance signals a need for review and potential adjustments to one's investment strategy.

Comparing a scheme's returns against its benchmark provides valuable insights. Consistent underperformance relative to the benchmark over time may warrant removing the scheme from one's portfolio. Identifying both underperformers and outperformers over a longer timeframe is crucial. Additionally, evaluating category average returns offers further perspective. Even if a scheme outperforms its benchmark, comparing it to its peers within the category can reveal whether it is truly a top performer or if there are better options available. Such assessments help investors make informed decisions about reallocating their investments to optimize returns and align with their financial goals.

What is the average return of mutual funds?

Average Returns of various mutual fund types:

Equity funds

• Historically average around 9% to 12% annually.
• Subject to market volatility but offer potential for higher returns.
• Can include subcategories like large-cap, mid-cap, and small-cap funds.

Bond funds

• Tend to offer lower returns compared to equity funds, averaging between 3% to 5% annually.
• Provide more stability and lower risk than equity funds.
• Include categories such as government bonds, corporate bonds, and municipal bonds.

Balanced funds

• Blend of equity and bond investments.
• Typically offer average returns between 5% to 8% annually.
• Aim to provide a balance between growth and stability.

Index funds

• Designed to mirror the performance of a specific market index.
• Average returns align closely with the performance of the underlying index, typically ranging from 5% to 8% annually.
• Tend to have lower fees compared to actiavely managed funds.

Sector funds

• Focused on specific sectors of the economy, such as technology, healthcare, or energy.
• Returns can vary significantly based on the performance of the targeted sector, ranging from negative to high double-digit percentages annually.
• Generally, considered higher risk due to concentration in a particular industry.

Types of mutual fund returns

Here are a few unique types of mutual fund returns:

1. Absolute returns: This is how much your investment grows in percentage, no matter how long you have invested. For instance, if you put Rs. 2,00,000 into a mutual fund and it grows to Rs. 2.5 lakhs in 4 years, your absolute return is 25%.
   
2. Annualised returns: This is the return you get each year. It takes into account the effect of compounding interest.
   
3. Total returns: This is the overall gain from a mutual fund, including any interest, dividend, distributions, and increase in value over time.
   
4. Point to Point returns: This is the annual return recorded between two specific points in time. You just need the start date and the end date of a mutual fund scheme to calculate this.
   
5. Compounded Annual Growth Rate: This is the annual return over a specific period that ends today. The formula to calculate trailing return is similar to point-to-point returns but uses today’s NAV and NAV at the start of the trailing period.
   
6. Annual return: This is simply the return earned from a scheme between January 1st and December 31st of a particular year.
7. Trailing return: It denotes the annualized return over a specific trailing period, concluding today. For instance, if a mutual fund scheme's NAV today stands at Rs.100, and it was Rs.60 three years ago, the formula for calculating the trailing return in Microsoft Excel would be (Today's NAV / NAV at the beginning of the trailing period) ^ (1/Trailing Period) - 1. Hence, the three-year trailing return would amount to 18.6%. Similarly, if the scheme's NAV five years ago was Rs.50, the five-year trailing return would be 14.9%.Read more about the difference between trailing and rolling returns in mutual funds.
8. Rolling returns: It represent a mutual fund scheme's annualised returns over a defined period, such as daily, weekly, or monthly. These returns are compared with the scheme's benchmark or fund category until the conclusion of the designated duration. Benchmarks could include Nifty, CNX - Midcap, CNX - 500, BSE - 200, BSE - Midcap, while fund categories might encompass midcap funds, large cap funds, balanced funds, diversified equity funds, among others.
9. Compound Annual Growth Rate (CAGR): It serves as a method for computing returns from mutual fund investments held for more than a year. This approach mitigates short-term fluctuations and volatility in the Net Asset Value (NAV) of the funds. The CAGR calculation assumes a steady pace of investment growth. To manually calculate the Compound Annual Growth Rate (CAGR), the equation is as follows:
   
   CAGR = [(Current Net Asset Value / Beginning Net Asset Value) ^ (1/number of years)] - 1

How to calculate mutual fund returns

Each type of mutual fund return comes with its own formula, as follows:

1. Absolute returns: This is how much your investment has grown in total. The formula is:
   Absolute return = {(Final investment value – Initial investment value)/Initial investment amount}*100
   
2. Annualised returns: This is the return you get each year, assuming your investment grows steadily. The formula is:
   Annualised return = ((1 + Absolute Rate of Return) ^ (365/no. of days)) – 1
   
3. Total Returns: This is the total gain from a mutual fund, including any interest, dividends, and increase in value. The formula is:
   Total returns = {(Capital gains + Dividends)/Total investment}∗100
   
4. Point-to-point returns: This is the yearly return between two specific dates. You need the start and end dates of a mutual fund scheme to calculate this.
   
5. Trailing returns: This is the yearly return over a period that ends today. It uses today’s NAV (Net Asset Value) and NAV at the start of the period. CAGR = {[(Present NAV / Initial NAV) ^ (1 / number of years)] −1} × 100
   
6. Annual return: This is the return earned between January 1st and December 31st of the year.

Factors affecting mutual fund returns

Here’s a simpler explanation of what can change mutual fund returns in India:

1. Performance of securities: A mutual fund invests money in securities like debt and equities. How these securities perform can really change the fund’s returns.
2. Fund manager’s performance: The choices and plans of the fund manager can have a big effect on how the fund does. A good manager can handle tricky situations and keep investors’ money safe.
3. Economic changes: Changes in government policy can really affect different parts of the economy. If a mutual fund is heavily invested in one sector, a good trend will help the fund make more money.
4. Size of the fund: It may seem like the bigger the fund the better the returns. However, the size of the fund does not have a greater impact on the return.
5. Cash flow: Money moving into and out of a mutual fund can change its performance.
6. Market/ sector/ industry changes: Changes in markets, sectors, or industries can affect how your mutual fund does.
7. Total Expense Ratio (TER): The TER, which includes all the costs that a fund incurs , may impact the returns.

To sum up, knowing about mutual fund returns helps you see if your investment is doing well and decide where to invest your money. Keep in mind, while higher returns sound great, they also mean more risk. So, when picking a mutual fund, think about how much risk you can handle and what you want to achieve with your investment.

Things to consider about mutual funds returns

When analysing the returns of mutual funds, several crucial factors merit attention:

1. Timeframe: Take into account the period for which returns are assessed. Short-term returns may exhibit greater volatility, while long-term returns offer a more comprehensive view of the fund's performance.
2. Benchmark Comparison: Compare the fund's returns against a relevant benchmark index representing similar investments. This comparison aids in determining whether the fund is surpassing or lagging behind its peers.
3. Risk-Adjusted Returns: Evaluate the risk-adjusted returns of the fund. Some funds may yield higher returns but come with increased risk. Understanding the correlation between risk and returns is vital for gauging the fund's suitability based on your investment objectives and risk tolerance.
4. Expense Ratio: Factor in the expense ratio of the mutual fund, reflecting the annual fees and expenses charged. Higher expense ratios can diminish overall returns and impact long-term performance.
5. Dividends and Distributions: Consider any dividends or distributions received from the mutual fund, as they significantly contribute to overall returns and influence the fund's tax efficiency.
6. Consistency: Seek consistent returns across various timeframes. A fund with a steady track record demonstrates stability and may prove more reliable than one with sporadic performance.
7. Past Performance: While past performance doesn't guarantee future results, it offers insights into the fund manager's ability to generate returns. Examine the historical performance, mindful that future results can be shaped by evolving market conditions.
8. Investment Objective: Evaluate whether the mutual fund's investment objective aligns with your financial goals and risk tolerance. Different mutual funds cater to diverse objectives, such as growth, income, or a combination thereof.

Conclusion

Mutual funds offer a compelling way to participate in the stock market and potentially grow your wealth over time. By understanding the various types of mutual funds, their risk-return profiles, and how to invest through a SIP (Systematic Investment Plan), you can harness the power of these investment vehicles to achieve your financial goals. Remember, thorough research, discipline, and a long-term perspective are key to success in mutual fund investing. Consider consulting a financial advisor for personalised guidance tailored to your specific needs and risk tolerance. With careful planning and the right investment strategy, mutual funds can be a valuable tool on your path to financial security.

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