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Annualized Return – Meaning, Formula and calculation explained.

Annualized Return in Mutual Funds
Annualised Return Time 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 annualised. The most popular one being the annualised return 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 returns are 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 is given in absolute basis and the returns from 1 year and above are given in 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% annualised 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% annualised return can double your money in 6 years. And 15% annualised return can double your money in less than 5 years! 

How to Calculate Annualised Return and Absolute 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 initial 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

Annualised Return

Annualised return is the amount of money the investment has earned for the investor per annum. CAGR is compounding of returns earned over a period of time. It provides a snapshot of the of an investment‘s performance but doesn’t give investors any indication about the volatility. Using annualised return 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 for annualised return

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

OR

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

Example

Date Fund NAV Time Period Absolute Returns Annualised Returns
Mar 28, 2018 30.51
Feb 28, 2018 31.02 1 month -1.64% -1.64%
Sep 29, 2017 28.79 6 months 5.97% 5.97%
Mar 31, 2017 25.82 1 Year 18.16% 18.16%
Mar 31, 2016 20.96 2 Years 45.56% 20.65%
Mar 31, 2015 21.73 3 Years 40.40% 11.98%
Mar 31, 2013 10.99 5 Years 177.62% 22.66%
Mar 31, 2008 9.75 10 Years 212.92% 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 annualised. The returns after 1 year are different. While the absolute returns show how much the investment has grown from the initial date, annualised return show 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. Annualised return normalises the absolute return and lets you know the returns over a given period of time.

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

Mutual funds returns are reported on an annualised 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 returns.

1yr: 18.16% annualised return => 1 lakh invested in this fund 1 year ago has become 1.18 lakh today

3yr: 11.98% annualised return => absolute returns of 40% in 3 years => 1 lakh invested in this fund 3 years ago has become 1.40 lakh today

5yr: 22.66% annualised return => absolute returns of 177% in the last 5 years => 1 lakh invested in this fund 5 years ago has become 2.77 lakh today.

5 year 22.66% annualised 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 principle of compounding at work growing one’s investment over the years!

Published on July 9, 2018