Mutual funds are becoming increasingly popular among investors looking to achieve financial independence and build wealth. However, for many, navigating the numerous options available in mutual funds and understanding their returns can be a challenge.
In this article, they discuss the importance of investors being able to understand and determine the return on their investment in mutual funds. Explore the how the performance of multiple systems and benchmarks can be compared over different periods of time.
Here are some key metrics investors should consider when evaluating a fund’s performance:
1. Point-to-point return or absolute return: This metric measures the percentage change in the value of an asset from the beginning to the end of a particular period. For example, if an investment grows from ₹10,000 to ₹15,000 within three years, then the point-to-point return is 50%.
2. Compound Annual Growth Rate (CAGR): CAGR is the average annual growth rate of an investment over a specific period of one or more years. It allows investors to compare the historical returns of different investments or portfolios and helps understand long-term growth trends. It is best used to evaluate the performance of investments that do not have intermediate cash flows.
3. Expanded Internal Rate of Return (XIRR): XIRR takes into account the timing and amount of each cash flow, giving a more accurate picture of the return on an investment. This is useful for investments with irregular cash flows or where investors invest different amounts periodically due to: B. Frequent withdrawals through Systematic Investment Plans (SIPs) or Systematic Withdrawal Plans (SWPs).
4. Rolling Returns: Rolling returns measure the average annual returns over different periods of time, thus indicating consistency in performance. Investors can use this to evaluate how different mutual funds perform in different market cycles. Analysing rolling returns over different time periods allows investors to avoid recent influences and gain a deeper understanding of past performance across market cycles, allowing them to make informed decisions.
In addition to comparing the performance of multiple schemes, investors also need to evaluate the performance of a mutual fund against a relevant benchmark. A benchmark is a standard index that represents a category of mutual funds or the entire market. Comparing a mutual fund’s performance with a benchmark can give an idea of how well or poorly the fund manager is performing.
Understanding and judging the investment returns of a mutual fund is essential for investors to make informed decisions. Understanding the returns helps investors evaluate the effectiveness of their investment strategy, track progress towards financial goals, and make necessary adjustments.