Mutual funds are a preferred choice for investors to meet their financial goals. A mutual fund is an investment vehicle, managed by professional fund managers, where individual investors’ funds are pooled and invested in a diversified portfolio of securities based on the investment objective of the scheme. Mutual funds generate returns which they either distribute to investors or retain within the scheme depending on the option selected by the investor. If the investor selects the ‘dividend payout’ option, then dividends are paid out to the investor. However, if the investor selects the ‘dividend reinvestment’ option or the ‘growth’ option, the dividends stay invested in the scheme and are reflected in the value of the NAV. The investor must assess the performance of his mutual fund investment to decide whether the fund has met with his returns expectation.
Assessing mutual fund returns
Mutual funds generate returns in the form of dividends and capital gains, which, in combination are defined as mutual fund returns.
There are three methods of assessing mutual fund returns:
- On a standalone basis
- Compared to the category the fund belongs to (for e.g. if the fund is a multi-cap equity fund, then its returns should be compared with other multi-cap equity funds) and with the average returns generated by the multi-cap funds category
- Compared to its benchmark index (for instance, a large cap equity fund may have the Nifty50 as its benchmark index; hence, returns should be compared with the returns generated by the Nifty50 index for the period under assessment)
There are a number of ways that returns from mutual fund investments can be computed. Let’s discuss some key methods:
- Absolute Return: This is the percentage increase or decrease in an investment. The time taken to generate these returns is not accounted for; however, this method is used for mutual funds with a tenure of less than one year.
- Annualized Return: This return considers the time period of investment. For instance, if you invest Rs 1 lakh in a mutual fund scheme and it grows to Rs 1.4 lakh in 3 years, the absolute return is 40% but your annualized return will be 11.9% after factoring in the compounding effect.
- Total Returns: A fund’s total return takes into account capital gains and losses from the securities held within the fund, dividends and interest earned by the fund as well as expenses charged by the fund. This return is a good reflection of the fund’s performance.
If the various methods of computing returns mentioned above baffle you, you could simply use a calculator for mutual fund investments available online. You cancarry out complex calculations with a simple click. Some calculators not only show the fund’s performance on a standalone basis, but also in comparison to other funds in the same category and to the fund’s benchmark index.