There are two parameters used to calculate the returns on Mutual Funds investment.
- Absolute Returns
- Annualised Returns
What are the Absolute Returns of a Mutual Fund investment?
Absolute Returns are the simple returns gained from the start to the present day, i.e. from one point to the other.
Absolute Returns = (Today’s Net Asset value {NAV} - Initial NAV) / Initial NAV) * 100
The most popular use of Absolute Returns is to calculate the returns for periods shorter than a year.
What are the Annualised Returns of a Mutual Fund?
A Mutual Fund's Annualised Return is the yield gained per year. It is the average of the HDFC Mutual Fund's monthly returns throughout the year.
CAGR refers to the "Compounded Annual Growth Rate." Compounding is the investment of gains earned and the principal. You can also use simple Annualised Returns, but CAGR is a better choice.
Annualised Return= ( 1 + Absolute Rate of Return) ^ ( 1 / No. of Years) - 1
Annualised Returns are useful in comparing returns of similar Mutual Funds.
Why do Investor Returns vary from the profits of Mutual Fund houses?
Investor Returns depend on:
- When you had made your investment
- The price you paid
- Your holding period
The difference between investor's returns and the fund's returns is a measure of how accurate the investor was in choosing when to invest.
There are a few reasons why the Mutual Fund's returns are higher than your returns.
Most people invest in the Mutual Fund when the market is soaring, and they see the fund performing well. A well-performing fund has a high NAV. So, the investor buys at a high price.
When the market reaches a low and the fund's performance drops, investors panic and sell. Optimism and despair control the investor's financial decisions. Situations lead investors to speculate rather than invest.
Over the years, the retail investor's holding time has reduced. You do not benefit with reduced holding time as you are unable to reap the rewards of compounding. Exponential results are possible only because of compounding which takes time to work.
As a result, the investor ends up with poor or mediocre returns.
How can you bridge the gap between Investor’s Returns and the Fund’s Returns?
Invest, don't speculate
Start investing early even if you can only invest small amounts. As your circumstances improve, you can increase your investment amount.
Stay invested in your well-performing investments until you achieve your financial goals.
Don't overpay
Investing is about never having to over-pay no matter how attractive the rewards appear to be.
Let's take an example. You invest in a Mutual Fund when its NAV is INR 450. When you bought the fund, the market was at its peak. Next year, the market undergoes a correction. The fund's value drops down to INR 300. It means that your fund's NAV will have to grow by INR 150 before you begin to realise any profits on your investment. That's why it is necessary never to overpay.
Avoid imitation
Do not imitate anyone else while investing. Someone else's hot tips could result in cold performances for your portfolio. Conduct a proper assessment of your risk appetite. Set your financial goals before you invest.
Appoint a reputed Financial Advisor
As retail investors, you might not have the time to research before you invest. Appoint a reputed Financial Advisor who will do the same on your behalf.
Refrain from panic selling
While no one can ever time the market, invest when prices are down. Every investment is subject to a cycle. What goes up, must come down and then go back up again. If market volatility is why the fund's performance has gone down, avoid panic selling.
Do not book losses and exit from your Mutual Fund in such times.
Use SIPs– Rupee Cost Averaging helps reduce the price
Systematic Investment Plans (SIPs) use Rupee Cost Averaging. It is a technique that helps you buy fewer units at a high price and more units at a lower cost.
The longer the term, the lower is your average buying price. To some extent, SIPs help you prevent troubles that arise from over-paying.
Disclaimer: Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
