If you’ve ever looked into investing in mutual funds, you’ve probably come across the term “annualised returns”. It may sound a bit technical at first, but don’t worry, it’s quite simple once you understand the basics. In this article, we’ll break it down step by step, so you’ll have a clear idea of what annualised returns are, how they work, and why they matter, especially if you’re investing in mutual funds through lump sum or SIPs (Systematic Investment Plans).
What Are Mutual Funds?
Before we talk about annualised returns, let’s have a quick refresher on mutual funds.
A mutual fund is an investment vehicle where money is collected from many investors and used to buy a mix of assets like stocks, bonds, or other securities. This pool of money is managed by professional fund managers who aim to generate good returns for investors.
When you invest in a mutual fund, you’re essentially buying a piece of that big investment pie.
Know More About What are Mutual Funds?
What is Annualised Return in Mutual Fund?
Now, let’s get to the main topic, what is annualised return in a mutual fund?
In simple words, annualised return tells you how much you’ve earned from your mutual fund investment each year on average, regardless of how many years you’ve invested. It helps to compare different investments fairly, even if they were held for different periods.
Let’s break that down a bit:
- It’s not just the total return you made.
- It’s the average return per year.
- It shows the compounded growth of your money over time.
So, when someone says, “This mutual fund gave a 12% annualised return over 3 years,” it means your money grew at an average rate of 12% each year for those 3 years, considering compounding.
Why Annualised Returns Matter
You might be wondering, “Why not just look at the total return?”
Here’s why annualised returns are better:
- They help you compare different mutual funds on equal footing.
- They give you a realistic picture of how your money grows year by year.
- They factor in the power of compounding, which is a big deal in investing.
So, if you’re comparing two funds, one held for 2 years and another for 5, annualised returns will help you see which one truly performed better per year.
How Are Annualised Returns Calculated?
You don’t need to be a maths genius to understand this, but here’s a simple explanation.
The formula to calculate annualised returns is:
Annualised Return = [(Final Value / Initial Value) ^ (1 / Number of Years)] – 1
Let’s take an example.
Suppose you invested ₹1,00,000 in a mutual fund, and it grew to ₹1,44,000 in 3 years.
Here’s how you calculate the annualised return:
- Final value = ₹1,44,000
- Initial value = ₹1,00,000
- Time = 3 years
Now plug into the formula:
= [(144000 / 100000) ^ (1 / 3)] – 1 = (1.44 ^ 0.3333) – 1 ≈ 1.129 – 1 ≈ 0.129 or 12.9%
So, your annualised return is 12.9%.
This means your investment grew at an average rate of 12.9% each year over 3 years.
What is Annualised Return in SIP?
Now that we’ve understood mutual fund returns, let’s answer another common question, what is annualised return in SIP?
An SIP or Systematic Investment Plan is where you invest a fixed amount every month (or week/quarter) instead of a lump sum.
Annualised return in SIP is a bit different because you’re investing money regularly over time. The return for SIPs is usually shown as XIRR, Extended Internal Rate of Return. It works similarly to annualised return, but it accounts for multiple cash flows (monthly investments) instead of a single one.
XIRR is the go-to method for calculating annualised returns in SIPs because it gives a fair idea of your average yearly return from all the monthly investments.
So, when your SIP statement says the fund gave an XIRR of 11%, it means your average return per year was 11%, after considering all your instalments.
Annualised Returns vs Absolute Returns
Let’s clear up another common confusion.
- Absolute Return shows the total return, regardless of time.
- Annualised Return shows the average yearly return.
For example:
If you invested ₹1 lakh and it became ₹1.5 lakh in 3 years:
- Absolute return = ₹50,000 or 50%
- Annualised return = ~14.5%
As you can see, absolute returns don’t tell you how long it took to get those returns. That’s why annualised returns are more useful when comparing investments over different time frames.
Things to Remember About Annualised Returns
Here are some key points you should keep in mind:
- Compounding is key – Annualised returns include the effect of compounding, which can significantly boost your gains over time.
- Not fixed or guaranteed – Mutual funds are market-linked, so annualised returns can vary depending on market performance.
- Better for long-term – Over longer periods, annualised returns give a more accurate picture of fund performance.
- Use for comparison – Always use annualised returns when comparing mutual funds with different durations.
How to Check Annualised Returns in Mutual Funds
Most fund houses and platforms show annualised returns for different time periods, like 1 year, 3 years, 5 years, and since inception.
Here’s how you can check them:
- Visit fund websites or investment platforms.
- Look at the fund’s performance section.
- You’ll see returns listed as 1Y, 3Y, 5Y CAGR, these are annualised returns.
- For SIPs, check the XIRR value in your statement or dashboard.
Conclusion
So now, you know what is annualised returns in mutual funds and why it’s such a crucial number to understand. Whether you’re investing a lump sum or through SIPs, knowing how much your money grows each year, on average, helps you make smarter decisions.
To quickly recap:
- Annualised return is the average yearly return on your mutual fund.
- It factors in compounding, unlike simple or absolute returns.
- It’s super useful for comparing funds across different time periods.
- SIPs use XIRR to reflect annualised returns across multiple instalments.
Investing might seem complex at first, but with simple concepts like annualised return under your belt, you’re already a step ahead.
