How Are Mutual Fund Returns Calculated

Similar to any other asset class, mutual fund returns are calculated by computing the value appreciation of your investment over a certain period in comparison to the initial investment you made. Your mutual fund has a net asset value or NAV. This value is indicative of the current price of your mutual fund, and therefore, it is used to calculate returns for your fund investments. But how are mutual funds returns calculated?

What Is Mutual Fund Return?

Mutual fund return, a composite of Net Asset Value (NAV) appreciation and dividend income, is a critical metric in investment evaluation. NAV, crucial in evaluating a fund’s worth, is calculated by deducting liabilities from the market value of assets and then dividing the resulting figure by the total number of outstanding units. Meanwhile, the market value of assets is determined by multiplying the unit price by the quantity of units in possession. Meanwhile, dividend income materializes through the division of the net distributed amount among investors by the unit price. This intricate formula encapsulates the essence of the financial adage that “money doesn’t grow on trees,” accentuating the imperative for strategic, active management to ensure money diligently works to earn profits for its owner. Thus, effective investment practices play a central role in enhancing overall returns and securing financial growth.

Types of Returns

Broadly, there are two types of returns when it comes to mutual funds investments. These are

Absolute Returns:

Such returns refer to the amount by which a mutual fund scheme has changed at the time of its redemption. Take, for instance, A who invests ₹1 lakh in a fund scheme at the beginning of 2016. In Jan of 2016, the mutual fund scheme’s value was ₹1.25 lakhs. A chooses to remain invested for three years. Hence, the absolute returns that are earned by A on his investment over a duration of 3 years can be computed as below:

Absolute Return = ( Final Investment Value — Initial Amount Invested) * 100 / Initial Amount Invested

= (1,25,000–1,00,000) * 100 / 1,00,000

= 25%

Annualised Return:

These types of returns refer to those that are earned by one’s mutual fund on a yearly basis. Annualized returns operate with the assumption that one’s mutual fund has grown at a constant rate, although this is often not the case. However, they give a decent estimate of what an investor can expect in the form of returns over a year of investing. Annualized returns are calculated through the following formula.

Annualized Return = (Final Investment Value ÷ Initial Amount Invested)^ (1/number of years)  — 1

Using the example of A as mentioned above, if we input all of the numbers, we get a rate of return of about 8.5% per annum.

The Difference in Mutual Fund Returns Calculation

The calculation of Mutual Fund Returns differs notably between closed-end and open-ended funds. Closed-end funds impose a maximum limit on the issuance of shares, while open-ended funds continually release new shares as their Net Asset Value (NAV) appreciates, known as the split rate. Unlike closed-end counterparts, open-ended mutual funds lack a fixed number of shares, allowing the trading of outstanding shares in the secondary market. In closed-end schemes, returns are determined based on the NAV at the time of purchase. Contrastingly, open-ended schemes permit profit realization through unit sales when there’s appreciation, and losses are limited to the original investment if the NAV declines. Schemes typically present returns over one, three, and five years, aiding investors in evaluating performance over specific periods. For instance, if Rs 10 lakh was invested in a plan, one might assess returns after three years.

Compounded Annual Growth Rate (CAGR)

A third means of assessing mutual funds returns is CAGR or compounded annual growth rate. CAGR gives us the growth of a certain investment over a certain time period. CAGR also takes into account the interest that is earned on one’s principal investment as well as any that is accrued on the interest itself. CAGR becomes an essential means of analyzing one’s investments’ returns since it is able to incorporate the time value of money.

As compared to absolute returns, CAGR offers investors a more comprehensive picture of how ‘good’ investing in a certain mutual fund scheme can be. It enables one to average down how volatile one’s returns over a certain investment horizon can be. However, when one’s investment stretches over a certain duration and is paid at irregular intervals in installments, calculating CAGR becomes a chore. In such cases, especially for SIPs, using Extended Internal Rate of Return is often used to predict returns on investments.

Extended Internal Rate of Return

XIRR or Extended Internal Rate of Return is used to calculate mutual fund returns for the SIP mode of investment. SIPs or systematic investment plans involve regularly investing small amounts of money into a mutual fund scheme at a certain predefined time interval. If one opts to pay monthly installments and they redeem their invested amount on a certain day, the returns for their SIP will vary based on their holding period. When you opt to invest via the route of SIPs, you buy the mutual fund scheme based on its NAV for that day of the month.

Once your invested amount is redeemed, you get the amount that is equivalent to the numbers of units you held overall multiplied by the NAV of your fund on the day you choose to redeem it. XIRR is essentially the aggregate of many CAGRs on every SIP investment you make. Calculating XIRR freehand is complicated so it is recommended you use a SIP calculator rather than attempting to check the CARG of each investment you make in your SIP. XIRR also accounts for irregular cash flows in case you have a systematic withdrawal plan in addition to your SIP. Your return value will be consolidated based on your investments as well as withdrawals.

Things to consider about mutual funds returns

It is common for mutual funds to be targeted toward long-term investors, in addition to seeking consistent and smooth growth with less volatility than what is seen in the market as a whole. Historically, a mutual fund can tend to underperform in comparison to the market average, especially during a bull market. However, it can also outperform the market’s average, particularly during a bear market. It is typical for long-term investors to have a lower risk tolerance since they are more concerned with reducing their risk than they are with maximizing the gains from their mutual funds’ investments.

When it comes to mutual fund returns, what is considered ‘good’ is largely a factor of the desired level of return as well as the individual investor’s expectations. It is likely that most investors will be satisfied by returns that roughly mirror the average returns seen from the overall market. Any number that can meet or exceed this goal will constitute a good annual return from one’s mutual fund. Any investor that seeks higher returns would be disappointed by the level of investment in mutual funds, particularly if they do not wish to remain invested for a long time.

When determining good returns, the current market performance, as well as broader economic conditions, are important considerations. Take for instance the case of an extreme bear market. During this time it is normal for stocks to drop on average by 10% to 15%, but a fund investor who can realize a 3% profit for the year might consider these to be excellent returns. Under more positive market conditions, the investor will likely be dissatisfied with those same levels of returns.

The Takeaway

There are a variety of mutual fund returns to look into before investing. Each of these can be affected by the market’s performance and general economic conditions. When it comes to how to calculate mutual fund return, you can use online mutual fund returns calculators to estimate your fund’s rate of return. Ensure you research well into mutual funds before you choose to invest in them.


How is mutual fund return calculated?

Key performance indicator NAV is calculated by deducting liabilities from asset market value and dividing the resulting amount by the total number of outstanding units. The unit price multiplied by the quantity of units held yields the asset’s market value. Divide the net amount allotted to investors by the unit price to get dividend income. Dividend income and NAV appreciation add up to the total return. To evaluate mutual funds’ returns in various market situations and make well-informed investment decisions, investors frequently track the performance of these funds across a variety of timeframes, including one, three, or five years.

How much return is good in a mutual fund?

The assessment of a satisfactory return in a mutual fund is subjective, hinging on individual financial objectives and risk tolerance. Investors commonly evaluate performance by comparing it to relevant benchmarks and industry averages. While indices like the S&P 500 are popular benchmarks for equity funds, the sufficiency of returns also relies on the fund’s strategy and the investor’s time horizon. Some may prioritize stable, consistent returns over heightened volatility. Investors need to align their expectations with financial goals, diversify their investment portfolios, and routinely evaluate their holdings. Consulting a financial advisor can offer personalised guidance based on individual circumstances.

Can there be negative returns on mutual funds?

Absolutely, the performance of mutual funds can be unpredictable. The market’s ebb and flow directly impacts the fund’s value, and if the securities within its portfolio decline, it could lead to an overall negative return. Various factors contribute to these setbacks, such as market volatility, underperformance in specific sectors or businesses, and economic downturns.

Investors must acknowledge the inherent fluctuations in the value of their mutual fund holdings. The ups and downs come with inherent risks. To navigate this landscape wisely, investors should grasp the mutual fund’s investment objectives, evaluate its historical performance, and factor in their own risk tolerance. These considerations play a vital role in effectively managing potential downturns in the market and making informed decisions about them.