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. We also explore 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 an asset’s value 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, the point-to-point return would be 50%.
2. Compound Annual Growth Rate (CAGR): CAGR is the average annual growth rate of an investment over a particular period of more than a year. It allows investors to compare historical returns of different investments and portfolios and helps in understanding 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 at regular intervals, such as: Frequent withdrawals through Systematic Investment Plans (SIPs) or Systematic Withdrawal Plans (SWPs).
4. Rolling Returns: Rolling returns measure the average annual return over different periods, and therefore indicate consistency in performance. Investors can use it to evaluate the performance of different mutual funds across different market cycles. Analyzing rolling returns over different periods helps investors avoid recency bias and gives them a better understanding of past performance across market cycles, allowing them to make informed decisions.
In addition to comparing the performance of multiple systems, investors should also evaluate how their investment fund compares to 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 to a benchmark provides insight into the fund manager’s performance.
Understanding and judging mutual fund investment returns is essential for investors to make informed decisions. Understanding returns allows investors to evaluate the effectiveness of their investment strategy, track progress towards financial goals, and make necessary adjustments.
