What are Mutual Fund Returns and Its types | Different types of MF Returns with example
When you buy a mutual fund, you are indirectly joining forces with others and collectively investing in a diversified pool of stocks, bonds or other securities. The objective is to get your original money to grow over time; the growth (or loss) is what people mean when they refer to a mutual fund return. However, return is not simply a number, as the term has layers to it, each is revealing a part of the story of your investment’s performance. Becoming familiar with the various returns is helpful because it will help you avoid seeing simply a chunky percentage (and calling it good), and with some reason, you should be able to find out exactly how much the fund is growing, if at all, when you account for the markets, the fees and taxes. For instance, you might see a fund quotation a really high “absolute return” without any context that didn’t talk about the risk it was taking to get there or the “total return” which includes dividends where the number quoted might be less than total return after costs.
What are Mutual Fund Returns?
Returns on mutual funds reflect a profit or loss from a mutual fund investment over a set period, usually presented as a percentage. This return is derived from the change in the portfolio’s Net Asset Value (NAV), dividends or interest earned, and capital gains or losses from the sale of securities in the portfolio, and can differ based on the fund’s performance, market conditions, and the time period in question.
Types of Mutual Fund Returns
Absolute Returns:
Absolute returns measures the total percentage change in the value of the investment over a given time frame, without accounting for time. It is an easy calculation often used for short-term investing (typically less than a year).
- Formula:
- Absolute return = [(Current Value of Investment – Initial Value of Investment) / Initial Value of Investment]*100.
- Example: You invest ₹10,000 in a mutual fund with an initial NAV of ₹100. After 6 months, the NAV rises to ₹120.
- Absolute return = ((120-100)/100)*100 = 20%
Annualized Returns:
You can take the annualized return and think of it as an average annual return for the time period of investment, rather than just a straight line percentage. This becomes particularly useful when you want to compare how two or more investments performed during various time frames and particularly for investment periods greater than one year.
- Formula:
- Annualized return = ((Current NAV value/Purchase NAV value) ^ (1/number of years)) – 1]*100
- Example: If the purchase NAV value of your mutual fund was Rs 20 and the current NAV value after 4 years is 25, the CAGR value will be computed as below:
- CAGR = [((25/20)^(1/4))-1] * 100 = 5.74%
Total Returns:
Total returns encompass all sources of income including capital appreciation (growth in NAV) and distributions (dividends or interest) that are reinvested in the fund. This represents overall performance of an investment.
- Formula:
- Total return = [(Capital Gains+dividend) – Initial Investment/Initial investment] * 100
- Example: You invest ₹10,000 at an NAV of ₹100. After 1 year, the NAV is ₹110, and you receive a dividend of ₹5 per unit (50 units, so ₹250 total), which is reinvested to buy more units. The final value becomes ₹11,250 (NAV increase + reinvested dividends).
- Total return = ((11,250 – 10,000)/10,000)*100 = 12.5%
Trailing Returns:
Trailing returns indicate how the fund has performed over a particular past period (for example, 1 year, 3 years, 5 years), ending on the current day. Typically, trailing returns are shown in fund fact sheets.
- Example: A mutual fund’s 3-year trailing return is reported as 10% per year. This means, on average, the fund delivered 10% annualized returns over the past 3 years, calculated using CAGR or total return methods.
Point-to-Point Returns:
These returns are calculated between two specific dates, often using absolute returns or CAGR, depending on the time frame.
- Example: From January 1, 2023, to January 1, 2025, a fund’s NAV grows from ₹100 to ₹130. The point-to-point return over 2 years (using CAGR):
- CAGR = ((130/100)^(1/2)-1)*100 = 14.02%
Rolling Returns:
Rolling returns measure the average annualized returns over multiple overlapping periods (e.g., every 3-year period within a 10-year timeframe). It helps assess consistency of performance.
- Example: A fund’s 3-year rolling returns from 2015 to 2025 are calculated for periods like 2015–2018, 2016–2019, etc. If the average of these periods is 12%, the fund’s 3-year rolling return is 12%.
Dividend Yield:
Dividend yield measures the income (dividends) generated by the fund as a percentage of its NAV. It’s relevant for dividend-paying funds.
- Formula:
- Dividend Yield = (Dividend per unit/ NAV)*100
- Example: A fund with an NAV of ₹100 pays a dividend of ₹4 per unit.
- Dividend Yield = (4/100)*100 = 4%
Key points
- Time Horizon: Absolute returns are suitable for short-term analysis, while CAGR and rolling returns are better for long-term performance.
- Reinvestment: Total returns and CAGR assume dividends are reinvested, which impacts the final value.
- Risk-Adjusted Returns: While not a type of return, evaluating returns alongside risk (using metrics like Sharpe or Sortino ratios) is crucial for a complete analysis.
- Tax Implications: Returns may be reduced by taxes on dividends or capital gains, depending on the fund type and jurisdiction.
Conclusion
Mutual fund returns can be simply defined as an amount of money that your investment has earned or lost over a defined time, usually this will be shown as a percentage. There are a few types of mutual fund returns, each providing a unique perspective of a fund’s performance. Absolute return shows the total gain or loss from a defined period, such as a 20% gain in a fund over six months. Annualized return converts that absolute gain into an annualized return. Compound annual growth rate (CAGR) gives a more smooth measure of a fund’s growth over the long run, such as 14.47% CAGR over three years. Total return will show the total gain/loss taking into account the change in value of the fund and any reinvested dividends. Trailing return looks only at prior returns over defined trailing periods. Rolling returns look at trailing returns but also show consistency in returns over time. Lastly, dividend yield indicates how much income is being provided through dividends. Each of these return calculations would provide the investor with an understanding of their investment performance, however, each is better suited for certain investment objectives and time horizons. Understanding these different types of returns allows investors to better compare mutual fund performance over time.
FAQs
How is annualized return different from absolute return?
Annualized return converts the total return to an annual rate, useful for comparing different time periods, e.g., 20% in 6 months becomes 40% annualized.
Which return type is best for short-term investments?
Absolute returns are best for short-term investments (less than a year) as they show total gain without annualizing.
Can I compare mutual funds using returns alone?
No, you should also consider risk, fees, and your investment goals, as returns don’t tell the full story.
Do mutual fund returns include taxes?
No, returns are calculated before taxes. Taxes on dividends or capital gains may reduce your actual returns.
Why is CAGR useful for long-term investments?
CAGR smooths out ups and downs to show steady annual growth, making it ideal for comparing long-term performance.