How to Calculate Returns on Mutual Funds?
Have you ever wondered how the returns on mutual funds is calculated or are trying to calculate the returns earned on the investments in mutual funds that were made several years ago. Let’s begin with understanding the three basic types of returns used to evaluate the performance of mutual funds i.e. absolute return, simple annualized return and compounded annualized growth rate (CAGR).
Absolute Return
Absolute return is the percentage change in the value of investment over the investment period. For instance, if you invested Rs. 10 lakhs for one year and the same Rs. 10 lakhs grows to Rs. 12 lakhs in one year, then the absolute return of your investment is 20 per cent ((12,00,000-10,00,000) / 10,00,000) X 100. Absolute returns are typically calculated when the holding period of an investment is less than one year.
Simple Annualized Return
Simple annualized return is calculated as:
(365 / Holding Period in days) X absolute return
Simple annualized returns are typically used for calculating returns from money market funds or cash where the holding period of an investment is less than one year. Nevertheless, it can also be used for calculating returns on equity investment for less than a year. For example, if you invested Rs 50,000 for 45 days and at the end of it grows to Rs 48000, your simple annualized return on investment would be around 54 per cent. ((365/45)*(48-45)/45)*100
Compounded Annual Growth Rate (CAGR)
Compounded Annual Growth Rate (CAGR) is the annual average rate at which an investment has grown over a period of time. The average here refers to geometric average and not arithmetic or simple average. This means you not only earn returns on your initial investment but also on your returns. Compounded annual growth rate is calculated as:
[(Final Value / Initial Value) ^ (1 / N) - 1] X 100, where N is Number of years.
Illustration:
Let’s assume you have invested Rs. 10 lakhs on 1st September 2015 and value of the investment as on 31st August 2018 is Rs. 15 lakhs. The compounded annual growth rate calculated is 14.47%. It is calculated as follows:
[(15,00,000 / 10,00,000) ^ (1 / 3) - 1] X 100
Although these methods are easy to calculate, investors must not rely on only this parameter. Investor must also understand the risk involved in it and also must look at financial goals.