Making money when you sleep – how do you do that? Well, it could be compounding interest. But how? The straight answer to this – by investing. Not all of us have an appetite to take big risks in the stock market, and most of us want more to take home than a conservative investment option like a bank RD.
What are Mutual Funds?
Mutual funds are a financial investment that pools shareholder funds and invests them in securities such as stocks, bonds, money market tools, and other assets. Mutual funds are entirely managed by professionals, or we can also call them money managers, who deploy the various assets of the fund in order to get greater capital gains or income for the fund’s investors. The portfolio of a mutual fund is constructed and managed to come together with the investment’s objectives that are mentioned in the prospectus.
Mutual funds offer you the access to professionally managed, as mentioned earlier – portfolios of stocks and other securities to individual investors or small investors. As a result of this – each buyer or investor shares in the fund’s profits or losses.
Mutual funds put money in a broad range of assets, and performance is usually measured as the change in the fund’s entire market value. This is determined by aggregating the performance of the underlying investments.
In India, mutual funds are issued by AMCs (Asset Management Companies) like – Groww Mutual Funds, Edelweiss Mutual Fund, Tata Mutual Fund, Mirae Asset Mutual Fund, and much more.
What are Mutual Funds Returns?
Mutual Fund returns, like those of other asset types, are computed by calculating the increase in the value of your investment over time in comparison to the initial investment. Mutual Fund Net Asset Value represents its price and is used to calculate returns on your Mutual Fund investments.
The following formula is used to compute the NAV: NAV = market value of assets minus liabilities/number of outstanding units
- The market value of an item is decided by multiplying the unit value by the number of units owned.
- Divide the net amount distributed among all investors by the unit price to calculate dividend income.
How are Mutual Fund Returns Calculated?
There are other ways to calculate the returns from mutual funds, and they are:
- Absolute Returns
Absolute returns show how much your mutual fund investment has changed in value at the time of withdrawal or redemption.
Formula: Absolute Return = ( Final Investment Value – Initial Investment) * 100 / Initial Investment.
- Compounded Annual Growth Rate
It shows you how much your investment has grown over a specific time period. Furthermore, it considers the interest earned on the interest as well as the interest earned on the interest itself.
CAGR is an important method for calculating investment returns since it takes into account the time value of money. When contrasted to absolute returns, it provides a more true picture of how profitable a mutual fund plan may be as an investment vehicle. Furthermore, CAGR allows you to determine how variable your returns can be over time.
When you continue to invest for a longer period of time by making many installments at unpredictable intervals, CAGR becomes ineffective. As a result, in circumstances such as SIPs (Systematic Investment Plans), the returns are estimated using a different technique.
- Annualized Returns
Annualized returns are the annualized returns earned by a mutual fund. These returns are calculated based on the assumption that your mutual fund plan has grown at a consistent rate, which is not necessarily the case. However, these returns provide an approximation of what you can expect from a year’s worth of investment.
Formula: Annualized Return = (Final Investment Amount / Initial Investment Amount)^ (1/number of years) – 1
- Extended Internal Rate of Return
The Extended Internal Rate of Return (XIRR) is a useful method for estimating mutual funds for SIPs. SIPs, as previously explained, involve investing a specific amount of money in a mutual fund scheme in installments at predetermined intervals of time. If you choose to pay monthly and redeem your money on a specific day, your returns for that SIP will vary based on how long you retain it. Furthermore, when you choose the SIP mode of investment, you buy the MF scheme at its current Net Asset Value (NAV).
When you redeem your investment, you will get a value equal to the total number of units you held multiplied by the net asset value of your fund on the redemption date. In other words, XIRR operates as a sum of numerous CAGRs on each SIP installment you make.
What You Have to Consider When Calculating Mutual Fund Returns?
Mutual funds are typically aimed at long-term investors since they provide constant growth while also protecting you from market volatility. In general, mutual funds have a propensity to underperform the market average during a bull market.
They can, however, outperform during a weak market. Long-term investors typically have a lower risk tolerance since they are more concerned with mitigating risk rather than maximising rewards from a mutual fund plan.
When discussing mutual fund returns, “good” returns are defined as those that meet an investor’s desired level of returns, financial goals, and expectations. As a result, there is no such thing as a one-size-fits-all mutual fund program. Most investors will be content with returns that are consistent with the market’s average.
Final Takeaway
There are different forms of mutual fund returns, and you will have to consider various factors in order to get the right form of calculation in place. So, make sure you are aware of that process. Or if this method is getting too tedious for you – you can always choose to use the online return calculators for your benefit.