How the Average Returns on Mutual Funds are Calculated

Mutual Fund investments are popular among individuals planning for financial growth over time. However, one must clearly understand how to calculate the average returns on Mutual Funds to assess their profitability and performance. Calculating average returns provides an idea about the fund’s growth and performance over a specific period. Accordingly, you can make informed decisions regarding your future investment strategy. In the following section, you will learn how to calculate the average returns on Mutual Funds.

Different ways to calculate the average returns on Mutual Funds include Absolute return, CAGR (Compounded Annual Growth Rate), XIRR (Extended Internal Rate Of Return), Annualised return, etc. Here’s a look at them:

1. Absolute Return

Absolute return indicates an investment’s upward or downward movement in percentage. Only the initial and current NAV (Net Asset Value) of a fund are needed for calculation. This method of calculating Mutual Fund returns is used for funds invested up to a period of one year.

The formula for calculating Absolute return is:

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

For instance, if the initial NAV was 25 and the current NAV is 30, the absolute return will be 20% for an investment period of 9 months.

2. Annualised Return

The investor must use the Simple Annualised Return (SAR) to calculate the annual return for a full year. However, the formula to calculate SAR requires calculating the absolute return first. The formula to calculate Annualised return is:

SAR = [(1 + Absolute Return) ^ (365/t)] – 1

Where,

Absolute Return: This is the total return that an investment has achieved over a specific period. It is calculated as:
Absolute Return = {(Present NAV – Initial NAV) / Initial NAV} × 100

t: The number of days for which the investment was held

365/t: Annualise the return by scaling it to a period of 365 days (one year). If the investment was held for fewer days or more days, this factor adjusts the return accordingly.

Taking the absolute return as 20%, over a period of 9 months, SAR will be

SAR = [(1 + 20%) ^ (365/270)] – 1 = 27.95%

3. CAGR (Compounded Annual Growth Rate)

One must calculate the Compounded Annual Growth Rate to determine an investment’s average annual growth rate. It is a standard measure to evaluate a Mutual Fund’s performance over a period, covering multiple years.

The formula to calculate CAGR is:

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

For instance, an investor invests ₹1 lakh in a Mutual Fund in 2017 with an initial NAV of ₹20 and after 5 years in 2022, the NAV increases to ₹70.

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

CAGR = 37.97%

4. XIRR (Extended Internal Rate of Return)

XIRR is an advanced method of calculating the average returns on Mutual Funds based on the cash flow and timing. The final calculation depends on the initial investment, subsequent investment and withdrawals.

SIP (Systematic Investment Plan) returns can be challenging to calculate due to changing investment durations and amounts. Therefore, traditional calculation methods may not be successful. Excel is an appropriate tool to calculate internal returns, considering multiple cash flows. Calculating SIP returns through XIRR requires the SIP amount, redemption date, amount and dates of SIP payments.

The XIRR formula is:

XIRR = XIRR (Values, Dates, Guess)

Steps involved in the calculation:

• Create a table with two columns - SIP dates in one column and corresponding amounts in another
• Enter the redemption dates and amounts in the last row
• Use the Excel XIRR function
• Enter the SIP values in the ‘value’ column and respective dates in the ‘date’ column
• Skip or leave the ‘Guess’ parameter empty
• Multiply it by 100 or format the result as a percentage to obtain the XIRR.

Factors Affecting Mutual Fund Returns

• Performance of the securities: Since Mutual Funds invest money in securities like equities and debt, the actual returns depend on the performance of these securities.
• Performance of the Fund Manager: The fund manager’s plans and choices significantly affect the fund’s performance. An efficient fund manager can make decisions to handle market conditions and keep the investments safe.
• Economic Changes: Changes in the Government and economic policies significantly affect the performance of the Mutual Fund. Mutual Funds which have heavily invested in a single sector experience the maximum impact of such changes.
• Fund Size: The bigger the fund size, the higher the returns.
• Cash Flow: Money flowing in and out of a Mutual Fund impacts its performance.
• Changes in the Market, Sector or Industry: Changes in these spaces affect the performance of a Mutual Fund.
• Total Expense Ratio (TER): It includes the costs of a fund and impacts the returns. The higher the TER, the lower the returns.

Using these calculation methods, investors can make informed decisions when selecting funds as per their risk tolerance and investment objectives. One may also use an online Mutual Fund Calculator to calculate the returns and make informed decisions. Conducting thorough research and consulting a financial advisor is advisable. Remember, calculating the returns accurately is essential to analyse the Mutual Fund's performance.