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06 May 2020

What is Annualised Return

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What is Annualised return?

Return is the wealth, or profit, that an investment will generate over a specific period of time. It is expressed as a percentage increase (decrease) in the value of the investment during that period.
Returns on mutual funds are shown in two ways: annualized or absolute. The most common method of showing mutual fund returns is annualised return or CAGR (compounded annual growth rate).

When analyzing which mutual fund to see, you can see its return for various time periods e.g. 3 months, 6 months, 1 year etc.

Returns for 1-3 months are usually shown as absolute returns and from 1 year onwards are shown as annualised. For example, if you see a 9% return for 3 months, that means the fund has had a return of 9% in 3 months. However, if you see 9% return for 3 years, that means the fund has returned 9% every year for the past 3 years, not a total 9% return over 3 years!

Remember that compounding interest is applicable to these investments. So if you have a 12% annualised return, you will double your money in just 6 years!

For example, if you see 22.6% annualised return over 5 years, that is actually an absolute return of 177% over 5 years!

How to Calculate Annualised Return and Absolute Return

Absolute Return
The simplest way to calculate returns is absolute returns. It calculates the total return on an initial investment. Here is the formula for absolute returns:Formula for absolute returns
Absolute returns = ((Present NAV – Initial NAV)/ Initial NAV) *100

Only use this formula for calculating returns for a mutual fund for a period of less than one year.

Annualised Return
On the other hand, annualised return calculates the return per year. Alongside annualised returns, you may find CAGR, which is the compounding of returns earned over a period of time.
Annualised returns provides a clear, transparent way for investors to evaluate mutual funds while accounting for volatility of the market. For example, mutual fund A has annualised returns of 6% vs. Mutual fund B’s annualised returns of 9%.

Formula for annualised return
Annualised return = ((1 + Absolute Rate of Return) ^ (365/no. of days)) – 1
OR
Annualised return = ((1 + Absolute Rate of Return) ^ (1/no. of years)) – 1
Example
The table below will show the NAV of XYS fund. As you can see, the returns for the first period (up to 1 year) are the same. However, after that the annualised return starts to differ, as it shows how the fund performed on an annual basis.

Annualised returns normalize the absolute return so you can understand them over a specific period of time.

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Why do 1-year returns for some funds appear more than 5-year returns?

Mutual funds report returns on an annualised basis, and these returns will go up or down over time. Therefore, sometimes you may see a ‘down’ year that impacts the longer term returns. However, long term investing and using a long-term horizon is the correct way to invest!

For example, let’s look at how much money you would make with an annualised return on a specific fund, and how much that exactly is in terms of absolute returns.
Time PeriodAnnualised ReturnAbsolute ReturnValue of Investment (Rs.)
1 Year18.16%18.16%1,18,160
3 Years11.98%40%1,40,000
5 Years22.66%177%2,77,000

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This publication is provided for general information purposes only and is not intended to cover every aspect of the topics with which it deals. It is not intended be advice. You must obtain professional advice before taking, or refraining from, any action on the basis of the content in this publication. The information in this publication does not constitute legal, tax, investment or other professional advice from North Loop or its affiliates. We make no representations, warranties or guarantees, whether express or implied, that the content in the publication is accurate, complete or up to date. All opinions expressed do not reflect the views of North Loop nor are endorsed by North Loop.