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Investing in mutual funds is a popular choice for individuals looking to grow their wealth over time. However, assessing the performance and profitability of these investments requires a clear understanding of how to calculate mutual fund returns. Mutual fund returns provide valuable insights into the growth or decline of your investment over a specific period. By analyzing these returns, you can evaluate the success of your investment strategy and make informed decisions for future investments. In this article, we will take you through the intricacies of calculating mutual fund returns step-by-step.

In this blog, we will take you through the intricacies of calculating mutual fund returns step-by-step. We will explore different methodologies, formulas, and metrics used to measure performance, such as annualized returns, total returns, and compound annual growth rate (CAGR). Whether you are a novice investor seeking to grasp the basics or an experienced investor looking for advanced insights, this guide provides a comprehensive understanding of mutual fund returns. Our aim is to equip you with the knowledge and tools necessary to evaluate the performance of your investments effectively.

What is Mutual Fund Return?

Mutual fund return refers to the gain or loss on an investment in a mutual fund over a specific period. It is a measure of the profitability and performance of the mutual fund. The return is typically expressed as a percentage and reflects the change in the value of the investment, taking into account factors such as capital appreciation, dividends, and distributions.

Mutual fund returns can be calculated for different timeframes, such as daily, monthly, quarterly, or annually. They provide investors with valuable information to assess the success of their investment and compare the performance of different mutual funds.

Also Read: What are the Advantages of Mutual Funds

It is important to note that mutual fund returns can be influenced by various factors, including market conditions, the fund's investment strategy, expenses, and fees. Understanding and accurately calculating mutual fund returns is essential for making informed investment decisions and evaluating the overall profitability of your investment portfolio.

Different Ways of Calculating Mutual Fund Returns

Different ways of calculating mutual fund returns include absolute returns, annualized returns, CAGR, and XIRR, providing varied perspectives on investment performance.

1. Absolute Returns

Absolute returns measure the total percentage increase or decrease in the mutual fund's value over a specific period. It is a straightforward calculation that does not consider the time factor or compounding effects. To calculate absolute returns, you only need the initial Net Asset Value (NAV) and the current NAV of the mutual fund. The NAV represents the price of one unit of the mutual fund. The formula for absolute returns is:

Absolute Return = (Present NAV – Initial NAV) / Initial NAV × 100

For example, if your initial NAV was 25 and the present NAV is 30, and you had stayed invested for nine months, the absolute returns would be 20%.

2. Annualised Return

Absolute Returns are useful for calculating returns on investments held for less than 12 months. However, if you want to assess your annual returns and determine how much you would have earned if you stayed invested for a full year, the Simple Annualized Return (SAR) is the appropriate metric to use. The simple annualized return is derived from the value of the absolute return.

The formula for annualized return is:

SAR = [(1 + Absolute Rate of Return) ^ (365/number of days)] – 1

Considering the previous example,

Simple Annualized Return = [(1 + 20%) ^ (365/270)] - 1

Therefore, with a 20% absolute return, the simple annualized return is approximately 23.3%.

3. Compounded Annual Growth Rate (CAGR)

Calculating CAGR helps you determine the average annual growth rate of your investment, providing a standardized measure to compare investment performance over time. It provides a smooth representation of the fund's performance over multiple years. 

The formula is:

CAGR = {[(Present NAV / Initial NAV) ^ (1 / Number of years)] - 1} × 100

To calculate the compounded annual growth rate (CAGR) for a lump sum investment, let's use the given example:

Assuming you invested ₹1 lakh in a mutual fund scheme in 2016 with an initial NAV of ₹20, and after five years in 2021, the NAV increased to ₹70.

CAGR = {[(₹70 / ₹20) ^ (1 / 5)] - 1} × 100

CAGR ≈ 14.87%

Alternatively, if you prefer using Excel, you can use the RRI function:

=RRI(Nper, PV, IV)

Where:

Nper = Time in periods (calculated in months)

PV = Present Value (ending value)

IV = Initial Value (beginning value)

This will give you the CAGR, which you can format as a percentage to obtain the result.

4. Extended Internal Rate of Return (XIRR)

XIRR is a more advanced method that takes into account the timing and amount of cash flows into and out of the mutual fund. It considers not only the initial investment but also subsequent investments and withdrawals. XIRR provides a more accurate picture of the fund's return when cash flows are involved.

Calculating returns from Systematic Investment Plans (SIPs) can be challenging due to varying investment durations for each installment. Therefore, traditional methods may not be suitable in such cases. To overcome this, we can utilize XIRR, a formula in Excel that calculates the internal rate of return considering multiple cash flows.

To calculate SIP returns using XIRR, you will need the following information:

• SIP amount
• Dates of SIP investments
• Redemption date
• Redemption amount

The formula for XIRR is:

XIRR = XIRR(Values, Dates, Guess)

Here are the steps to calculate XIRR in Excel:

• Create a table with two columns.
• Enter the SIP dates in one column and the corresponding SIP amounts in another column.
• Add the redemption date and redemption amount in the last row.
• Use the XIRR function in Excel.
• Select the values column to include the SIP values and the dates column for the respective dates in the formula.
• The "Guess" parameter can be skipped or left empty.
• Format the result as a percentage or multiply it by 100 to obtain the XIRR in percentage terms.
• By following these steps, you can determine the returns from your SIP investments using the XIRR function in Excel.

Also Read - How to Invest in Mutual Funds: Explained in Easy Ways

Things to Consider about Mutual Funds Returns

When evaluating mutual fund returns, there are several important factors to consider:

Timeframe

Consider the time period over which the returns are measured. Short-term returns may fluctuate more significantly, while long-term returns provide a broader perspective on the fund's performance.

Benchmark Comparison

Compare the fund's returns to an appropriate benchmark index that represents similar investments. This helps assess whether the fund is outperforming or underperforming its peers.

Risk-Adjusted Returns

Evaluate the risk-adjusted returns of the fund. Some funds may generate higher returns but at a higher level of risk. Understanding the risk associated with the returns is crucial for assessing the fund's suitability for your investment goals and risk tolerance.

Expense Ratio

Consider the expense ratio of the mutual fund, which represents the annual fees and expenses charged by the fund. Higher expense ratios can eat into your overall returns and impact long-term performance.

Dividends and Distributions

Take into account any dividends or distributions received from the mutual fund. These can significantly contribute to the overall returns and impact the fund's tax efficiency.

Consistency

Look for consistent returns over multiple time periods. A fund that consistently delivers solid returns demonstrates stability and may be more reliable than a fund with sporadic performance.

Past Performance

While past performance is not indicative of future results, it can provide insights into the fund manager's ability to generate returns. Consider the fund's historical performance, but also remember that future performance can be influenced by changing market conditions.

Investment Objective

Assess whether the mutual fund's investment objective aligns with your own financial goals and risk tolerance. Different funds may have varying objectives, such as growth, income, or a combination of both.

Must check - How to Analyse Mutual Fund Performance?

By considering these factors, we can make more informed decisions when analysing mutual fund returns and selecting funds that align with our investment objectives and risk tolerance. It's important to conduct thorough research and consult with a financial advisor if needed, as mutual fund investments involve risks and individual circumstances may vary. Remember, accurate calculation is the key to making informed investment decisions and achieving financial goals.