Types Of Returns in Mutual Funds

It's all about the numbers. As an active investor, you might have invested in multiple mutual fund schemes over the years. However, when wealth creation is your ultimate goal, there are some numbers you just cannot ignore.

Why? Because not all mutual funds generate the same returns. And to ensure you're parking your funds in the right place, you need to review the performance of these schemes regularly to determine the underperformers and outperformers.

While investors often depend on financial advisors or tools to estimate the return on their investment, different ways of calculating returns can present a different picture. Here we will talk about the six different types of mutual fund returns that you should know about.

Annualised Returns

Annualised returns or Compounded Annual Growth Rate (CAGR) measures the growth of investment value in a year by considering the effect of the compounding rate of interest. Annualised returns are useful for comparing different mutual funds with varying tenures.

Annualised returns = (Current NAV value/Purchase NAV) 1/n – 1

where n=holding period in years

Absolute Returns

Absolute return refers to the increase or decrease in the investment measured as a percentage, irrespective of the investment tenure. These returns are usually calculated for mutual funds with a tenure of less than a year and are fairly easy to calculate. If the tenure exceeds a year, you will have to calculate annualised returns.

Absolute returns = [(Selling Price-Cost Price)/Cost Price] x 100

Trailing Returns

Trailing returns are the annualised returns over a specific trailing period ending today. Trailing returns are relevant if you wish to assess the past performance of your funds. Such returns are calculated from a particular date of the recent year to any past date for 1/3/5/10 years.

Trailing returns = (Current NAV/NAV at the beginning of the trailing period) 1/n – 1

where n= trailing period

Point to Point Returns

It is the annualised return generated by a mutual funds scheme between two points in time. For instance, if you want to understand how a mutual fund performed during a specific period, say, between 2018 and 2021, you will have to calculate the point-to-point returns.

To assess point-to-point returns of a mutual fund scheme, all you need to do is determine the NAV of the funds at the start and end dates and calculate the annualised returns.

Point to Point Return = [(NAV at the end date – NAV at the start date)/NAV at the start date] x 100

Total Returns

The total returns are the actual returns earned from the mutual fund investment, including the dividends, capital gains, and interest over the period. Total returns are useful to gauge a mutual fund's performance, helping you make a better investment decision.

For instance, suppose you are looking to invest in either of two companies, A and B, which have the same growth percentage in a year. But company A has already paid a portion as a dividend to its investors. In this case, the total returns will be greater for company A. Thus, it reflects a better performance than company B.

Total Returns = [(Capital Gains + Dividend)/ Total Investment] x 100

Rolling Returns

Rolling returns are the annualised returns over a specific period – daily, weekly, or monthly – measuring the scheme's absolute and relative performance at regular intervals. Rolling returns are significant in evaluating a fund's performance because it reflects how a fund's performance has improved consistently, and not just over the latest period.

Since it offers an unbiased analysis, rolling returns are widely accepted as the most reliable measure of a fund's performance.

Extended Internal Rate of Return (XIRR)

XIRR is a method used to calculate the return on investments that have multiple cash flows at different times. Unlike simple return calculations, XIRR considers both the timing and amount of investments and withdrawals, giving a clearer picture of actual returns.

Calculating returns for Systematic Investment Plans (SIPs) can be tricky since each instalment has a different holding period. Traditional methods may not work well in such cases. XIRR helps solve this issue by factoring in all cash flows and their respective dates.

To Calculate SIP Returns Using XIRR, You Need:

• SIP investment amounts
• Dates of each SIP instalment
• Redemption date
• Redemption amount

You can use Excel to calculate XIRR with the following formula:

XIRR = XIRR(Values, Dates, Guess)

Here, "Values" refers to the cash flows (investments as negative values and redemptions as positive values), "Dates" are the corresponding transaction dates, and "Guess" is an optional estimate of the return.

Using XIRR gives a more accurate measure of returns, especially for SIPs or investments with multiple transactions.

How to Use Different Kinds of Returns?

Different types of returns help investors evaluate and compare investments based on their financial goals. Here’s how to use them:

Absolute Returns – Use these to measure total gains or losses over a specific period. This is useful for short-term investments but does not account for the time taken to generate returns.

Annualised Returns – Use these to compare funds over different timeframes. They convert total returns into a yearly format, making it easier to assess long-term performance.

Rolling Returns – Use these to check consistency. They calculate returns over multiple overlapping periods, helping to evaluate how a fund performs across different market conditions.

Trailing Returns – Use these for a quick performance snapshot. They show returns from today’s date back to a fixed period (e.g., last 1, 3, or 5 years), which helps in comparing recent fund performance.

Point-to-Point Returns – Use these to measure returns between two specific dates. They help evaluate performance over a set timeframe but may not reflect long-term consistency.

Total Returns – Use these to assess overall performance, including both capital appreciation and dividends. This helps compare funds with different payout structures.

XIRR (Extended Internal Rate of Return) - Best for SIP investors, as it calculates returns when investments and withdrawals occur at different times.

By using these return types together, you can better analyse mutual fund performance and choose investments that align with your financial goals.

Things to Consider About Mutual Funds Returns

When reviewing mutual fund returns, keep these key aspects in mind-

Time Period- Look at the duration for which returns are measured. Short-term returns can be volatile, while long-term returns give a clearer picture of the fund’s performance.

Comparison with Benchmark- Check how the fund performs against a relevant benchmark index. This helps determine whether the fund is outperforming or underperforming similar investments.

Risk-Adjusted Returns- Some funds offer higher returns but carry more risk. Understanding the balance between risk and reward is important when aligning the fund with your financial goals.

Expense Ratio- Consider the fund’s expense ratio, which includes annual fees and charges. A high expense ratio can reduce overall returns and affect long-term growth.

Dividends and Payouts- Factor in any dividends or distributions received, as they contribute to total returns and impact tax efficiency.

Consistency of Performance- A fund with stable returns over different time periods is often 

a better choice than one with erratic performance. Look for funds with a solid track record.

Historical Trends- While past performance does not guarantee future results, it can offer insights into how the fund has responded to different market conditions.

Investment Objective- Ensure the fund aligns with your financial goals and risk appetite. Some funds focus on growth, while others prioritize steady income or a balanced approach.

By evaluating these factors, you can make informed decisions and choose a mutual fund that suits your investment needs.

To Sum Up

Since mutual funds are a long-term investment, it is crucial to assess and compare the expected returns before investing. With a better understanding of various types of returns, you'd be in a better position to analyze the performance of different mutual funds.

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FAQs

How often are mutual fund returns distributed to investors?

Mutual fund returns are distributed based on the fund type. Growth funds reinvest earnings, while dividend-paying funds distribute returns periodically - monthly, quarterly, or annually. The distribution schedule depends on the fund’s policy and market performance.

What is the average return on a mutual fund?

The average return varies by fund type and market conditions. Equity mutual funds in India typically offer 10-15% annual returns over the long term, while debt funds provide 6-8%.

Is a 10% return on a mutual fund good?

A 10% return is considered decent for equity mutual funds, especially in the long run. It beats inflation and offers steady wealth growth. However, returns depend on market trends, investment duration, and the fund’s risk level.

What is the average ten-year return on mutual funds in India?

Historically, mutual funds in India have delivered annual returns of around 9-12%. However, returns can be higher based on market conditions. In some cases, mutual funds have generated an average of 20% over ten years, reflecting strong market performance and long-term growth potential.