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Annualized Return – Meaning, Formula and calculation explained.

Annualized ReturnTime Taken to double money
5%14 years 2 months
8%9 years 0 months
10%7 years 3 months
12%6 years 1 months
15%4 years 11 months
20%3 years 9 months
25%3 years 1 month

‘Return’ is the yield that an investment generates over a period of time. It is the percentage increase or decrease in the value of the investment in that period. Returns on mutual funds are expressed in 2 different ways, viz, absolute and annualized. The most popular one being the annualized returns or CAGR (Compounded Annual Growth Rate).

A mutual fund fact sheet shows the fund facts and the most important to us as investors are its return. The return on an investment is usually given for 1-month, 3-month, 6-month, 1-year, 3-year, 5- year and so on.

The returns for 1 to 3 months are given in an absolute basis and the returns from 1 year and above are given in an absolute basis. So when you see a 5% under the 3-month column, it means the fund has given 5% in 3 months’ time. 12% annualized return in 3 years means 12% return earned every year for the past three years and not 12% total return in 3 years.

Albert Einstein hasn’t simply said that compound interest is the 8th wonder of the world. Compounding can do wonders to your money. 12% annualized return can double your money in 6 years. And 15% annualized return can double your money in less than 5 years! 

annualized return
annualized return

Absolute Return vs Annualized Return

Absolute Return

Absolute returns, also known as point-to-point returns, calculate the simple returns on initial investment. To calculate this return all one needs is the beginning value – NAV and ending NAV (present NAV). In this method, the duration of holding the fund is not important. One usually uses absolute returns to calculate returns for a period of less than one year.

Formula for absolute returns

Absolute returns = ((Present NAV – Initial NAV)/ Initial NAV) *100

Annualized Return

It is the amount of money the investment has earned for the investor per annum. You can also calculate it as a percentage value for an annualized rate of return. CAGR is compounding of returns earned over a period of time. It provides a snapshot of an investment‘s performance but doesn’t give investors any indication about the volatility.

Using it gives a clearer picture when comparing various mutual funds that have traded over different periods of time. However, this is applicable only if you re-invest your gains every year.

Formula to calculate the annualized returns

Annualized return = ((1 + Absolute Rate of Return) ^ (365/no. of days)) – 1

OR

Annualized return = ((1 + Absolute Rate of Return) ^ (1/no. of years)) – 1

Calculation of annualised return in mutual fund

DateFund NAVTime PeriodAbsolute ReturnsAnnualized Returns
Mar 28, 201830.51
Feb 28, 201831.021 month-1.64%-1.64%
Sep 29, 201728.796 months5.97%5.97%
Mar 31, 201725.821 Year18.16%18.16%
Mar 31, 201620.962 Years45.56%20.65%
Mar 31, 201521.733 Years40.40%11.98%
Mar 31, 201310.995 Years177.62%22.66%
Mar 31, 20089.7510 Years212.92%12.08%

The above table shows the NAV of an ELSS fund, (which has been taken only for the purpose of illustration). The returns up to 1 year are the same in the case of absolute and annualized. The returns after 1 year are different. While the absolute percentage show how much the investment has grown from the initial date. On the other hand, the annualized percentage shows how much the fund grew annually to reach that current return.

This doesn’t mean the fund grew at a certain rate every year. It’s just the average growth of the fund year on year over the investment period. Annualized return normalizes the absolute return and lets you know the growth on an investment over a given period of time.

Why 1-year returns for some funds are higher than its 3 or 5-year returns?

Mutual funds return on an investment is reported on an annualized basis. And mutual fund returns fluctuate across years. This is the reason why 1-year returns may appear higher than 3 years returns.

Let me take you through a small example.

The same fund which is one of the top funds in tax saving category of mutual funds has the following annualized performance:

1yr: 18.16% annualized return => Rs 1 lakh invested in this fund 1 year ago has come to a final value of Rs 1.18 lakh today

3yr: 11.98% annualized return => absolute returns of 40% in 3 years => Rs 1 lakh invested in this fund 3 years ago has come to a final value of Rs 1.40 lakh today

5yr: 22.66% annualized return => absolute returns of 177% in the last 5 years => Rs 1 lakh invested in this fund 5 years ago has come to a final value of Rs 2.77 lakh today.

5 year 22.66% annualized return mean that money invested 5 years ago in the fund has grown 22.66% every year, not 22.66% overall but instead 177% overall. This is the summarized interpretation of annualized performance. This is the principle of compounding at work growing one’s investment over the investment period!

Published on July 9, 2018