In India, we seem to have a ‘love-hate’ relationship with the share bazaar (aka stock market).
Those who love it swear by its potential to make them rich beyond their wildest dreams.
And those who claim to ‘hate’ the stock market are often driven by a fear of the unknown, rather than a true dislike of it. The inherent risks and the potential (there’s that word again!) for huge losses keep a lot of people away from direct equity investments.
If you’re one of the haters and have vocalised your hate/fear to anyone with a financial education, background or experience, you might have received one piece of advice that resonated with you: “Invest in mutual funds! Low risk, high rewards!”
But is this really true?
The answer to this question lies in understanding how mutual funds returns are calculated.
If you have ever wondered what is absolute return in mutual fund, how to calculate return on mutual fund or how and where you can find a high return mutual fund, then this guide is perfect for you.
So without further ado, let’s dive in!
Before we get into the technicalities on how to calculate mutual fund return, here are a few useful terms to set the stage. In the beginning, they may seem intimidating – or more like financial mumbo-jumbo – but once you get used to them, they will become part of your mutual fund lexicon. And that can only be a good thing!
As the name suggests, a lump sum investment is a ‘one-time’ investment. It is usually made when the investor has a substantial disposable amount of money in hand.
Under a Systematic Investment Plan (SIP), an investor invests/deposits a certain amount in a mutual fund scheme at periodic intervals.
Compounded Annual Growth Rate or CAGR is a number that explains the growth of a particular investment over a specific time period. It incorporates the ‘time value’ of money in order to calculate the interest earned on principal investment PLUS the interest earned on the accrued interest.
Net Asset Value is the price at which an investor buys one unit of a mutual fund. NAV is calculated once at the end of each trading day and it applies to both lump sum and SIP mutual fund investments.
MF not giving the returns you hoped for or expected? You might decide to ‘exit’ the MF. But some MFs require that you pay a fee to do so. The amount varies from one fund to another and is usually some percentage of your original investment.
An AMC is a mediator who pools in money from multiple investors and invests it in equity, bonds, money market instruments and other types of securities. Investors are then assigned a specific number of mutual fund units proportionate to their investment.
This is a dilemma that almost every potential MF investor faces.
In general, investing through an SIP offers two critical advantages over a lump sum investment:
SIP offers some more advantages. If you don’t have a large amount on hand but would still like to invest in mutual funds, a SIP is a good option. You can start with an amount that’s as low as 500 rupees and increase it as and when you can. Finally, a SIP can be automated to make the entire process simple and hassle-free.
Nonetheless, when it comes to your money and your investments, there is no ‘right’ or ‘wrong’ answer to the question of which mutual fund is ‘better’. Whether you opt for a lump sum investment or start a SIP depends on your current investment capability, risk profile, lifestyle, future financial goals and other factors.
Most mutual funds are aimed at long-term investors and seek relatively smooth and fairly consistent growth with less volatility than the overall market. During bull markets, mutual funds tend to underperform compared to the market average. But they outperform the market average during bear markets.
So, what is a ‘high return mutual fund’? Even better, can we calculate mutual fund ‘best’ return?
The answers to these question would depend on what defines a ‘high’ or ‘best’ return. Like the lump sum/SIP debate, there are no black-and-white answers here, but many shades of grey! Economic conditions and the market’s performance are among the most important considerations in determining a good return on mutual fund investment. Moreover, whether a return is good or not is also largely defined by the investor’s expectations and desired level of return.
There are many ways to calculate mutual funds returns or mutual fund return rate. These methods apply to both lump sum and SIP investments. Which method you use depends on what you are trying to calculate and why.
As the name implies, this is the return calculated over a period of 1 year and expressed as a time-weighted annual percentage. In simplest terms, annual return is the gain or loss of your initial mutual fund investment over a one year period.
This number allows you to analyse the MF’s performance over any given year you hold the investment. It is used more frequently among investors because it is relatively simple to calculate.
Annual return = (Ending NAV – Beginning NAV) / Beginning NAV
Suppose the NAV on your MF was 100 on 1st January 2020. On 31st December 2020, your NAV rose to 110.
Then your Annual return for the year 2020 would be = (110-100)/100 = 0.1 or 10%
This calculation is similar to the calculation for annual return. However, unlike the latter, it can be used to understand the simple returns on your investment at any point in time, not just at the end of the year. The formula is useful for calculating returns when the holding period is less than 12 months. Since it does not take into account the time period of investment and its compounding effect, it is rarely used to measure or evaluate a fund’s performance over a longer time.
Point-to-point return = [(Current NAV – Beginning NAV) / Beginning NAV] x 100
Suppose you purchased your MF on 27th May 2019 with NAV of 100. On 26th August of the same year, your NAV rose to 110.
Then your point-to-point return for this 3-month period would be = (110-100)/100 = 0.1 x 100 = 10%
Annualised return is used in a variety of ways to evaluate a mutual fund’s performance over time. Unlike annual return, it is based on the full investment holding period, regardless of whether it is shorter or longer than one year.
Here’s how the annualised return is calculated:
Annualised Return = [(1 + R1) x (1 + R2) x (1 + R3) x …. x (1 + Rn)]1/n – 1
where n = number of investment years
Suppose you invested in a MF in 2019 and stayed invested for 5 years. First, calculate the annual return for each of those 5 years. Then add these annual returns and divide the total return by the number of years.
Annual return for 2019: 3%
Annual return for 2020: 7%
Annual return for 2021: 5%
Annual return for 2022: 12%
Annual return for 2023: 1%
Annualised Return = [(1 + 0.03) x (1 + 0.07) x (1 + 0.05) x (1 + 0.12) x (1 + 0.01) ]1/5 – 1
Annualised Return = 5.53%
If the time period is greater than 1 year, CAGR is a better way to depict returns because it incorporates the time value of money. It represents a mean annual growth rate that smoothens out volatility in returns (which are bound to occur) over the investment horizon.
CAGR = (Ending value / Beginning value)1/n– 1
Suppose you invested 1 lakh in a mutual fund three years back. The beginning NAV for the mutual fund was Rs 20. Now, the NAV is Rs 40.
CAGR = 25.99%
Compared to absolute returns, CAGR presents a better picture of how well a particular mutual fund investment scheme is performing. However, when the investment stretches over a span of time with regular instalments (SIP), it becomes difficult to calculate. Here’s where Extended Internal Rate of Return (XIRR) can be more useful to predict returns on investment.
XIRR calculates the ‘internal’ rate of return or annualised yield for a schedule of cash flows that occur at irregular intervals.
XIRR refers to the aggregation of multiple CAGRs for a SIP investment. In a SIP, you keep investing regularly over a long period and get back the maturity amount upon exit. Depending on the NAV of the scheme on the day you invest, you get a certain number of units which you keep accumulating from Day 1. On the day you exit the scheme and ‘redeem’ your total units, you get the maturity amount. This amount is the NAV on that day multiplied by the total units.
To calculate the returns on your MF investment using XIRR in Excel, you don’t need the NAV. You only need to know the SIP amount, dates of SIP investments, date of redemption and maturity (redemption) amount.
Suppose you invested Rs 2000 per month starting on 1st Jan 2020. You stayed invested for 6 months (this short period is only to simplify this illustration!) At the end of this period, you redeemed an amount of Rs 11,000.
|Date of SIP||Amount|
XIRR = 45.27% per annum (use Excel)
If you would like to automatically calculate your mutual fund returns, you can do so using a mutual fund SIP return calculator or mutual fund lump sum return calculator (depending on your particular mutual fund). This simple online tool will calculate your fund’s returns according to your investment horizon to give you the investment value at maturity. You can easily adjust the calculator’s variables such as nature of investment (SIP or lump sum), investment amount, frequency (in case of SIP), expected rate of returns, etc.
We hope you found this guide useful! Mutual funds can be a wise investment with good returns, if done systematically and with an eye on the future. If you’d like to learn more about mutual funds, how they work, their benefits, how to invest in them and some of India’s top return mutual funds, check out our other articles below!
Taxation on mutual funds is a complex topic. Taxes paid on your mutual fund investments vastly depend on factors such as what kind of funds you have invested in, the duration of your investment, which income tax slab you belong to and so on.