# 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?

## Types of Returns

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

### 1. 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%

### 2. 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.

### 3. 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.

### 4. 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.