How to Calculate Returns on Mutual Fund Investments?

The first point of comparing mutual funds is the returns they generate. However, did you know that mutual fund returns can be of many types? So the next question is how to calculate them, and which can be considered to be the true measure of mutual fund returns? Get answers to these questions and more in this blog and enhance your mutual fund knowledge. 

What are mutual fund returns?

Mutual fund returns refer to the profit or growth an investor earns from investing in a mutual fund. When investors invest in a mutual fund, their money is pooled with funds from other investors and managed by a professional fund manager. This manager then invests in various assets such as stocks, bonds, or other securities. The returns from a mutual fund can come from three main sources, i.e., an increase in the value of the fund’s investments (capital gains), dividends earned from shares held by the fund, and interest income from debt instruments. These returns are typically expressed as a percentage of investment; for example, a 10% return means the investment grew by 10% over a specific period. However, mutual fund returns are not fixed and can fluctuate based on market conditions, and past performance does not guarantee future results.

What are the different types or methods of calculating mutual fund returns?

Mutual fund returns can be calculated using different methods that represent different forms of returns. The details of the same are explained below.

Absolute Returns

Absolute return shows the total increase (or decrease) in the value of a mutual fund investment, without considering how much time it took to grow. It simply compares the current value to the original amount invested. This type of return is best used for short-term investments (less than 1 year). However, the biggest drawback of this type of return is that it does not reflect the return per year if the investment is held for a longer period.

The formula to calculate absolute return is,

Absolute Return = (Current NAV - Initial NAV) / Initial NAV * 100

For example,

Consider Investor A buying mutual fund units with a NAV of Rs. 105, and after 1 year, the NAV is Rs. 115. The absolute return on this,

Absolute Return = (Current  NAV - Initial NAV) / Initial NAV * 100

Absolute Return = (115 - 105) / 105 * 100 = 9.52%

Annualised Returns

Annualised return tells you how much your investment has grown on average per year. It gives a clearer picture when the investment is held for more than one year. It helps investors understand how a mutual fund has performed each year, rather than just the total return over multiple years. This is often the same as CAGR (explained next), especially for lump-sum investments.

Simple Annualised Return (SAR), on the other hand, is a method used to calculate how much a mutual fund investment would earn in a full year, even if the investor held it for a shorter period. It helps compare different investments on an annual basis.

The formula to calculate simple annualised return is,

SAR = [(1 + Absolute Rate of Return) ^ (365 / t)] - 1

Where,

T = number of days the investment is held.

For example,

Consider Investor B invested in a mutual fund when the NAV was Rs. 100, and after 180 days (6 months), the NAV became Rs. 110. The SAR in this case will be,

Step - 1: Calculate absolute return 

Absolute Return  = (110-100) / 100 * 100 = 10%

Step 2: Apply the SAR Formula,

SAR =  [(1 + Absolute Rate of Return) ^ (365 / t)] - 1

SAR = [(1+0.10) ^ (365/180)] - 1

SAR = [(1.10 ) ^ 2.0277] - 1 = 1.219 - 1 = 0.219 = 21.9%

CAGR

CAGR (Compounded Annual Growth Rate) shows the average annual growth rate of an investment, assuming the money has been growing at a steady rate every year. CAGR is a useful method for comparing mutual funds over longer durations, especially when the investment is made as a lump sum. It helps measure the real growth per year and is considered to be a standardised measure of comparing mutual fund returns.

The formula for calculating CAGR is,

CAGR = {[(Present NAV / Initial NAV) ^ (1 / Number of years)] - 1} * 100

For example,

Consider Investor C investing in a mutual fund with an initial NAV of Rs. 1,00,000 and present NAV of Rs. 144000 in 3 years. The CAGR for this fund will be calculated as under,

CAGR = {[(144000 / 100000) ^ ?] - 1} * 100

CAGR = 13%

XIRR

XIRR is an advanced and accurate method used to calculate returns from mutual fund investments that involve multiple cash flows, such as a Systematic Investment Plan (SIP). Unlike basic return methods, XIRR considers each SIP instalment's amount and date, along with the final redemption value, giving a true picture of actual returns. Traditional return formulas do not work well for SIPs because each payment stays invested for a different number of days. XIRR solves this by using a built-in formula in Excel. 

To calculate SIP returns using XIRR, follow these simple steps:

• Open Excel and create a table with two columns, one for dates and one for investment amounts.

• Enter each SIP date and the corresponding SIP amount (as a negative value because it is an outflow).

• Add the redemption date and final amount received (as a positive value since it is an inflow) in the last row.

• Use the formula XIRR (values, dates) in a new cell, and you can skip the ‘guess’ part.

• Format the result as a percentage or multiply it by 100 to see the return in percentage terms.

Investors can easily and accurately calculate the returns from their SIPs by using XIRR, even if the investments were made on different dates and for different amounts.

What are the factors to consider while calculating mutual fund returns?

Calculating mutual fund returns is essential for every investor to make informed investment decisions. The factors to be considered while calculating mutual fund returns are highlighted below. 

• Consider the Type of Investment - The method of return calculation depends on how the investor puts money into the mutual fund. If the investment is made in one go (lump sum), then CAGR is the right method. If the investment is made regularly, like through monthly SIPs, then XIRR gives a more accurate picture of the returns.

• NAV Should Be Checked Carefully - NAV (Net Asset Value) is the price of each unit of a mutual fund. To calculate returns correctly, the investor must know the NAV on the day they bought the fund and the NAV on the day they check or redeem the investment.

• Consider the Duration of Investment - How long the investment is held plays a key role in return calculation. For short periods (less than a year), absolute returns work well. For longer durations (more than a year), annualised return or CAGR is more suitable to understand the average yearly growth.

• Comparison with Benchmark - It is helpful for an investor to compare their fund’s performance with a benchmark index like Nifty 50 or Sensex. This helps to know whether the mutual fund is doing better than the general market or not.

• Consider Risk and Volatility - While calculating returns, it is also important to consider the level of risk the investor is taking. A high-return fund may also have high ups and downs (volatility). Comparing returns along with risk measures like standard deviation or the Sharpe ratio gives a better understanding.

• Dividends Can Affect Returns - If the investor has chosen a dividend or income distribution option, any payouts or reinvestments can impact overall returns. In the growth option, dividends are automatically reinvested, which can lead to higher long-term returns.

• Market Timing Affects Short-Term Returns - Returns can vary depending on when the investor enters or exits the market. For example, investing during a market high and redeeming during a low can reduce returns. So, market timing plays a bigger role in short-term returns, though it matters less over the long term.

What is a mutual fund return calculator?

A mutual fund return calculator is an easy-to-use online tool that helps investors calculate the returns they can earn from their mutual fund investments. It shows the growth of an investment over time based on details like the amount invested, duration, expected rate of return, and investment type (lump sum or SIP). The calculator uses basic return formulas like CAGR or XIRR to give an idea of potential profits. These calculators are free and available on many financial websites, including online platforms provided by stockbrokers.

Uses of Mutual Fund Calculator

• Estimates future returns based on investment amount and duration.

• Helps compare different mutual funds to choose the best one.

• Shows the difference between SIP and lump sum investments.

• Useful for planning financial goals like retirement, education, or buying a house.

• Saves time and effort by doing all the calculations automatically and eliminating the chance of human error.

Conclusion

Understanding mutual fund returns is an important aspect for investors to make informed, smart decisions about their portfolios. Investors can calculate mutual fund returns in many ways, such as absolute return, annualised return, CAGR, and XIRR, depending on how and when the investment is made. This can help investors choose the right fund that can align with their return expectation and their investment goals to have an optimum investment portfolio and build wealth with more confidence and clarity.

This article talks about a crucial aspect of mutual fund investment, ensuring investors pick the right funds and have a true understanding of mutual fund returns. Let us know your thoughts on this topic or if you need further information on mutual fund returns, and we will address them. 

Till then, Happy Reading!

Read More: Pros and Cons of Mutual Fund Investing