Have you ever invested in the dividend option of a mutual fund and then wondered how to compute the return on your investment or do you have doubts about the accuracy of returns that you have computed for mutual fund investments made several years ago. If yes, this article should help you find some answers. To begin with, let us understand the three basic types of returns that are used to evaluate the performance of mutual funds – absolute return , simple annualised return and compounded annualised return (CAGR).
What is absolute return ?
Absolute return is nothing but the percentage change in the value of your investment over the holding period. For example , if an investment of Rs.1,00,000 grows to Rs. 1,20,000 , the absolute return is 20 % (20,000/1,00,000). Absolute returns are typically used to calculate returns when the holding period of an investment is less than one year.
What is simple annualised return ?
Simple annualised return is computed as follows : (365/holding period in days ) x the absolute return. Simple annualised return should
ideally be used for calculating returns from cash or money market funds where the holding period is less than one year.
What is compounded annualised return (CAGR) ?
Compounded annualized return indicates the annual average rate at which an investment has grown over a period of time . It is generally used for investment periods of one year and more. The average referred to here is the geometric average and not an arithmetic average , which means it assumes that you not only earn returns on your original investment but you also earn returns on your returns. The formula used for calculating compounded annualized return is :
{(Final value / initial investment amount ) ^ (365/holding period in no. of days ) -1 } x 100 or use
{(Final value / initial investment amount ) ^ (1 /N)-1 } x 100 , where N = number of years
Example : Let us assume that you had invested an amount of Rs. 1,00,000 on 1st April 2005 and the value of the investment on 31st January, 2009 was Rs. 1,50,000. In this case , the compounded annualised return on your investment as on 1st January, 2009 would be 11.14% – calculated as { (1,50,000 / 1,00,000 ) ^ (365/1401) -1 } x 100 While it is relatively easy to use these three methods in computing
returns from the growth options of mutual funds , it becomes a bit tricky to compute returns from dividend options. Investors very often
opt for the dividend option in a mutual fund scheme as it provides various benefits such as regular income , tax efficiency etc. However ,
when it comes to calculating returns on such investment , investors often tend not to include the dividends they have received. The
appropriate method to measure the performance of schemes , where the investment is made in the dividend option , is to calculate the “ Total
Total Return “ by factoring in the dividends.
You can get to check NAVs and returns of various mutual funds schemes on www.valueresearchonline.com on different time frames.
So what is total return ?
Total return includes capital appreciation as well as the dividends earned by the investor. While calculating total return , the dividends
received by investors are added back to the final value of investment and then returns are calculated – absolute, simple annualized or
compounded annualized – depending on the type of scheme and the holding period of the investment.
Let us take an example where you have invested an amount of Rs.1,00,000 and you have received a dividend of Rs.2,000. Assuming that the current value of your investment is Rs.1,15,000, the total return on your investment can be calculated as –
(Final value + Dividends Received –Invested Amount) / (Invested Amount ) x 100 = (1,15,000 + 2,000 – 1,00,000 ) / (1,00,000 ) x 100 = 17000 / 1,00,000 x 100 = 0.17 x 100 = 17%
If an investor chooses the dividend re-investment option , the return computation has to be based on the total current value of his
investment , which should include the value of units bought initially and the value of the units that have been received by re-investing
dividend.
For example : You bought 10,000 units for an initial investment of Rs.1,00,000 (at Rs. 10 per unit ) and subsequently received 200 units
by re-investing the dividend of Rs.2,000 at Rs.10 .If the current NAV is Rs.11, then the total return on this investment is calculated as :
{(Total number of units x current NAV –Initial Investment )/ Initial Investment )} x 100 = {(10,200 x 11 – 1,00,000)/1,00,000 )} x 100 =
12.20 %
Final Word
While calculating the performance of your mutual fund investment :
1. Remember to add back the value of the dividends received .
2. Decide on the appropriate type of return to be calculated based on the holding period and the type of the scheme you have invested in.
So ,if you want to learn more about mutual funds then checkout wealth management & personal finance management courses on www.elearnmarkets.com
This article is written by Mr Siddhartha Goenka , C.F.P.
Senior Manager – Knowledge at Elearnmarkets.com
. Share your views in the comments section below.
Very well elaborated article! Calculating returns on mutual funds is really a difficult thing. You have provided very detailed information. Thanks for sharing!