Long-term Investment: Good Annual Return for a Mutual Fund

Mutual Fund is an asset that professional fund managers oversee. It acts as an investment vehicle for people looking for exposure to the capital market. The primary objective is to earn a good annual return on the investment amount. Here is a full breakdown of a Mutual Fund, the returns and how it works as a long-term investment opportunity.

Deciding if a Mutual Fund Annual Return is Good

Deciding whether the Mutual Fund annual return is good or not depends on an individual’s relative judgement based on his/ her investment goals. The overall market and economic conditions also play an important role. Moreover, investors evaluate the Mutual Funds against a benchmark like the broad index to compare their returns. For instance, if the S&P 500 falls 5% in a year and a large-cap fund only falls 3.5%, one may consider it good. Investors may measure the returns annually at different times of the year or once in several years.

Definition of a Good Mutual Fund Return

A Mutual Fund is an excellent investment option for a long-term investor who seeks growth over a period. Since a long-term investor usually has a low-risk appetite, he/ she is more concerned about reducing the risk of his/ her investment rather than gaining maximum profit.

An investor’s expectations also play a role in what he/she considers good Mutual Fund annual returns. For instance, many investors are satisfied by returns equivalent to the average overall market returns. Any number exceeding that goal will be a good return. However, those seeking higher profits may feel disappointed by similar levels of returns.

Other important points to consider when deciding if the return on an investment is good include the market performance and economic conditions. For instance, in bear market conditions, the stocks may drop by 10-15%. A fund investor who realised a 3% gain for the year may consider this as an excellent return. However, the investor may feel dissatisfied with a similar return under more positive market conditions.

Annual Return vs Annualised Return

For a clearer picture of Mutual Fund Annual Return, one must understand the difference between annual return and annualised return. Here’s an overview:

Annual Return

Annual return is the percentage change in investment over a period of one year. Calculating the annual return allows an investor to analyse a fund's performance during a year. Investors calculate annual returns more frequently because it is simpler to measure than annualised returns.

To calculate the annual return, one must determine the investment’s price during the initial holding period and at the end of one year. Then, subtract the initial price from the end price to measure the difference between the investment's price over time. Although this calculation gives an idea of the total change in the fund's price over a year, it does not consider stock price volatility during this duration.

Annualised Return

Annualised return is the percentage change in investment over different periods longer or shorter than a year but measured as an annual return rate. An investor uses it in various ways to evaluate a fund’s performance over a period. To calculate the annualised return rate, one must first calculate the annual return as mentioned above. However, the final result depends on the full investment holding period, which is not necessarily one year. The next step to calculate the annualised return is to enter the corresponding values in the following formula:

Compound Annual Growth Rate (CAGR) = (Ending Value / Beginning Value) ^ (1 / N) - 1

Where:

• Ending Value is the final value of the investment
• Beginning Value is the initial value of the investment
• N is the number of years.

Types of Mutual Fund Returns

Let’s look at the different types of Mutual Fund returns:

Absolute Return

This indicates your investment growth in percentage, irrespective of the investment horizon. For instance, if an investment of  ₹ 2 lakh grows to ₹ 2.5 lakh in four years, the absolute return is 25%.

Total Return

Total Return indicates the overall return from a Mutual Fund investment, including dividends, interest, value increases and distributions over time.

Point to Point Return

This is an annual return recorded between two particular points in time. Calculate this return starting from the first start date and till the end date of a Mutual Fund scheme.

Trailing Return

This denotes the annualised return of a fund over a particular trailing duration, concluding on the present date. For instance, if the NAV of a Mutual Fund scheme was ₹ 60 three years ago and it is ₹ 100 today, one may calculate the trailing return using the following formula: Today's NAV/ NAV at the beginning of the trailing period) ^ (1/ trailing period) - 1. With this calculation, the trailing returns over the three years are 18.6%.

Rolling Return

It represents a Mutual Fund’s annualised return over a specific period, such as monthly, daily or weekly. Compare this with the scheme's fund category or benchmark until the end of the particular duration. These benchmarks include Nifty, BSE - Midcap, BSE - 200, CNX - 500, CNX - Midcap, etc., and fund categories include Midcap, Large Cap, Balanced and Diversified Equity Funds.

Compound Annual Growth Rate (CAGR)

Compound Annual Growth Rate or CAGR is a method to calculate a Mutual Fund investment’s return over a period longer than a year. The best thing about this method is that it reduces short-term volatility and fluctuations in the fund’s NAV and assumes a gradual speed of investment growth. The formula to calculate CAGR is as follows:

CAGR = (Current Net Asset Value/ Beginning Net Asset Value) ^ (1/number of years) – 1

Before investing, an investor must understand his/ her goals over a particular time horizon. He/ she can measure the fund's performance and determine whether the Mutual Fund’s annual return is good enough to meet objectives by knowing the expected returns. That is why it is crucial to research well before choosing a Mutual Fund for investment and pick a reliable fund manager to make decisions for maximum growth.