‘Return’ is the yield generated by an investment over a time period. This is the percentage increase or decrease in the investment value over that period. Mutual fund returns are expressed in two different ways, i.e., absolute and annualized return. Annualized return or CAGR (Compounded Annual Growth Rate) is the most popular.

A fact sheet from the mutual fund reveals the facts about the fund, and the most significant to us as investors is its return. The returns are usually issued for 1 month, 3 months, 6 months , 1 year, 3 years, 5 years etc. The returns are given in absolute basis for 1 to 3 months, and the returns from 1 year and above are given in absolute foundation. So if you see a 5 percent under the 3-month column, it means that the fund has given 5 percent within 3 months. 12% Yearly Return in 3 years means 12% Yearly Return in the past 3 years and not 12% Year Total in 3 years.

Albert Einstein hasn’t just said that the 8th wonder of the world is compound interest. Compounding can perform wonders on your money. Annualized return of 12 per cent will double your money in six years. And an annualized return of 15 per cent can double your money in less than five years!

Content Table-

How is Annualized Return and Absolute Return calculated?

Absolute Return

Annualized  Return

Examples

Why are 1-year returns higher than the 3- or 5-year returns for other funds?

How is Annualized Return and Absolute Return calculated?

Absolute Return

Absolute returns, also known as point-to-point returns, measure an initial investment’s basic returns. To measure this return all one wants is the NAV (present NAV) initial and ending. The time of keeping the fund isn’t relevant in this process. One typically measures returns using absolute returns over a period of less than one year.

Absolute Return formula

Absolute returns = ((Present NAV – Initial NAV)/ Initial NAV) *100

Annualized Return

Annualized return is the amount of money that the investor has received per annum. CAGR represents a compounding of returns earned over time. It offers a snapshot of the success of an investment but does not provide any hint about the uncertainty to investors. Using annualized return gives a better image when comparing various mutual funds that have traded over different time periods. This is only applicable, however, if each year you reinvest your gains.

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 table above shows the NAV of an ELSS fund, (which was taken for illustration purposes only). In the case of absolute and annualized, the returns up to 1 year are the same. Returns differ after 1 year. While the absolute returns show how much the investment has grown since the initial date, the annualized return shows how much the fund has grown each year to reach the current return. This does not mean that each year the Fund grew at a certain rate. It is only the fund’s average year-on-year growth. Annualized return normalizes the absolute return and helps you to know the returns for a given time span.

Why are 1-year returns higher than the 3- or 5-year returns for other funds?

The returns of the mutual funds are reported on an annualized basis. And the returns of the mutual funds fluctuate over the years. This is the reason why returns of 1-year can seem higher than returns of 3 years.

Let me take  by a few examples.

The same fund which is one of the top funds in the group of tax-saving mutual funds has the following returns.

1yr: Annualized return of 18.16 percent = > 1 lakh invested in this fund 1 year ago is now 1.18 lakh.

3yr: 11.98 per cent annualized return = > 40 per cent absolute return in 3 years = > 1 lakh invested in this fund 3 years ago today is 1.40 lakh.

5yr: 22.66 per cent annualized return = > 177 per cent absolute return over the last 5 years = > 1 lakh invested in this fund 5 years ago today has become 2.77 lakh. 5 Year 22.66 percent annualized return means that the money invested 5 years ago in the fund increased 22.66 percent annually, not 22.66 percent overall but 177 percent overall instead. This is the idea of compounding one’s investment at work rising over the years!

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