When you invest in mutual funds via a SIP or in a lump sum, you do so with the primary goal of earning high returns. These returns are calculated in two ways. The first is an absolute return, and the second is known as the annualized return. This article talks about what the latter means in mutual funds and how it differs from the former. Read on to find out.
What does an annualized return mean in mutual funds?
Annualized return is the total amount your investment has earned in a year. Annualized return is also known as Compounded Annual Growth Rate (CAGR) and gives you an investment’s earnings over a certain period. It only indicates the growth rate of your investment and not the volatility of market risk associated with the investment.
What are the advantages of calculating annualized returns in mutual funds?
The annualized returns of mutual funds have several uses for investors. Some of these have been mentioned below:
- You can use the annualized returns of different mutual funds to compare their performance.
- It helps you gauge the historical returns and the rate at which your investment capital has grown over time.
How can you calculate the annualized return in mutual funds?
You can use the following two formulas to calculate the annualized return in mutual funds:
Annualized returns = ((1 + absolute rate of return) x (365 / the number of days)) – 1
Annualized return = ((1 + absolute rate of return) x (1 / the number of years)) – 1
Is annualized return the same as absolute returns?
The term annualized returns are often confused with absolute returns. However, as stated above, these are two different ways to calculate your mutual fund returns. While annualized returns indicate the rate at which your investments grow in a certain period, absolute returns give you the returns earned from one point of time to another. This is why it is also referred to as point-to-point returns.
Absolute returns give you the returns earned on the initial investment (point one) up to the closing date of the asset (point two). This is generally used to calculate returns over less than one year.
Here is the formula to calculate absolute returns:
Absolute returns = ((Present NAV – Initial NAV) / Initial NAV) x 100
Here, NAV is the Net Asset Value of the mutual fund.
To sum it up…
Understanding the different ways to calculate your returns can help you compare the performance of various mutual funds and pick investments that are suited to your goals. It can also help you gauge the performance of your assets.
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