Mutual Funds (MF) have rapidly become a popular investment. While their features & returns attract investors, many people are still unclear regarding the mutual fund return calculation.
Yes, mutual funds offer a simple and convenient way to grow wealth; however, you should only invest in them once you know the anticipated mutual fund returns and how they are calculated.
So, let’s understand how to calculate mutual fund returns in order to make the most prudent investments.
There are several types of mutual funds, such as equity, debt, hybrid, index, thematic, sectoral, multi-asset funds, and more. But did you know there are also different ways mutual fund returns are calculated and depicted?
Here are the common types of returns you can expect from mutual funds.
An absolute return is the change in the total value of the MF from the time of its purchase to the date it is being calculated, which is usually the time of the redemption of its units. It is expressed as a percentage.
As the name suggests, annualised return is the change in the value of an MF calculated on a yearly basis. It is expressed as a percentage and is usually used to depict returns for a period of less than one year.
If you wish to calculate returns for a period of more than one year, it can be done using CAGR. While annualised returns can also be used for this purpose, the returns are market linked and may not be the same over the entire period considered for calculation. Hence, CAGR is used to give more accurate information.
The previous mutual fund returns types are well suited for lump sum investments.
However, if you are using the SIP mode to invest a fixed amount every month, then each purchase of units stays invested for a different period of time. You may not get an accurate portrayal of your returns using the types mentioned above. XIRR is the best way to calculate returns on SIP investments.
Now that you know the four popular types of expressing mutual fund returns, let us find out how to calculate them using each.
Formula: [(Current NAV – NAV at the time of purchase) / NAV at the time of purchase] × 100
NAV stands for Net Asset Value and is the price per unit of the mutual fund.
If the NAV was 50 when you initially invested in the MF and now the NAV stands at 75, then using the formula, you get the result of 50. This means your absolute return on investment was 50%.
[(75 - 50)/50] x 100 = 50
Formula: Absolute Returns / Investment Period
The absolute return calculated using the previous formula is agnostic of the investment period since it just considers the initial and final NAV values. Let us assume your investment period was three years.
Annualised returns calculation assumes the investment has grown at a constant rate over the investment period. Using the formula, you will find that the annualised return is 13.33%
50/3 = 13.33
Formula: [(Final Investment Value / Initial Investment Amount) ^ (1/number of years invested)] – 1
The assumption of a constant return rate may not always hold true in the real world with its ever-fluctuating market. Compounded Annual Growth Rate considers the different growth rates for different phases of the investment period and gives you an overall average. It is considered a more accurate form of representing returns.
Let’s take an example. You purchased 1000 units for three years. At the time of purchase, the NAV was 50. It reached 60 by the end of the first year, 65 by the end of the second, and at the end of the third year, it stood at 75.
What would your actual returns be over the entire investment period on an annual basis, considering the interim variations in the value?
[(75,000 ÷ 50,000) ^ (1/3)] – 1 = 14.5
This means you have earned a return of 14.5% over the period of 3 years.
Calculating XIRR can be tedious as it involves multiple inputs, such as the monthly SIP amount and the corresponding dates of the investment. In case of redemptions or switches, you will also need the date of redemption and redeeming value.
Since each SIP investment results in the purchase of a handful of units at varying market prices prevalent on the date of the SIP, the factors of this calculation are beyond the realm of manual abilities.
Some people may use MS Excel to do this calculation using the function and formula XIRR = XIRR (Values, Dates, Guess). The good news is we’ve made a calculator that makes calculations much easier and gives a more accurate picture of your returns.
Having understood how to calculate mutual fund returns, you can see that it can be a cumbersome process. The Fi SIP calculator works like a charm here, and you can play around with the calculator to see how you can maximise your returns. This tool is free to use with varying permutations and combinations.
To calculate annualised returns, first find out the absolute return, which can be done by using the formula: [(Current NAV – NAV at the time of purchase) / NAV at the time of purchase]
Now, divide the absolute return by the investment period to get your annualised return.
A mutual fund's performance relies on its underlying assets and the market's overall and sector-specific performance. Past performance doesn't guarantee future returns. Hence, besides reviewing historical returns, it's crucial to carefully examine the fund's terms, invested assets, risk level, etc. Thorough research is essential for wise investments.
Taxation applies to any returns generated from investments in mutual funds. The profits obtained from mutual fund investments are categorised as "capital gains" and are subject to taxation.
The mutual fund's net asset value (NAV) is calculated daily after subtracting the expense ratio, resulting in returns that already account for the expenses. In simpler terms, the expressed returns reflect what investors have gained after the expense ratio has been deducted.
The average return of mutual funds varies depending on the specific funds and market conditions. Historically, it has been around 5% to 10% per year, but this can differ significantly based on the fund's investment strategy, asset class, and overall performance. Past performance is not indicative of future results, and investing in mutual funds carries inherent risks.
A good rate of return on mutual funds is typically considered to be above the average market return. Historically, an annual return of 7% to 10% is often seen as satisfactory for long-term investors. However, individual financial goals and risk tolerance should be taken into account when evaluating what is considered a "good" rate of return.