The primary advice you get when choosing mutual fund options is to "choose the investment vehicle based on its returns." These returns correspond to gains from your mutual fund investments. When you explore the options, you will find two types of returns "“ absolute and annualised.
This blog explains absolute return vs annualised return, as well as its similarities and differences to make smart investment choices with the best website for mutual fund investment.
What is Absolute Return?
Absolute return refers to the total loss or gain of the mutual fund investment for the entire investment duration. It is not dependent on the market performance. The absolute return is the actual return you gain from your investment at the end of the investment period. It includes all dividends and capital gains the investment has earned throughout the period.
Investors who want to ensure capital preservation and steady returns over a long-term period will focus on absolute return. The best app to invest in mutual fund delivers positive returns by outperforming the market. Therefore, prioritising absolute returns can help you remain invested, regardless of market volatility.
The absolute return formula is:
Absolute Return={Final investment value-Initial investment Initial investment } * 100
For example, if you invested Rs. 20,000 in a mutual fund and by the end of the year, your investment has grown to Rs. 21,600, then
Absolute Return={21600-20000 20000}*100 = 8%.
This means you earned an absolute return of 8% on your mutual fund investment. Here, the market performance is irrelevant. It shows the actual growth of investment. The goal of mutual fund investment is to generate absolute returns consistently over the investment period.
As investments focused on absolute returns don't vary during market fluctuations, they also have little opportunity to capitalise on bull markets. Such investments offer capital preservation and appreciation at a reduced risk.
What is Annualised Return?
Annualised return, also widely known as Compound Annual Growth Rate (CAGR), calculates the average rate of return from a mutual fund over a specific period. It assumes that the rate of return remains constant and calculates an annualised growth rate.
The annualised return also considers the compounding effect of the investment. This shows that even small changes in the return can affect the overall performance of the mutual fund over the long term. It provides a standardised measure of the performance of the investment. The annualised return of mutual fund investment is helpful to compare different types of mutual fund investments.
The annualised return formula is:
Annualised Return=- 1
For example, for a mutual fund investment that generated a total return of 20% over 3 years, the
Annualised Return=(1+0.20)13- 1 = 6.26%
This means the investment generated an annual return of 6.26% over three years.
Absolute Return Vs Annualised Return: Differences
| Aspect | Absolute Returns | Annualised Returns |
|---|---|---|
| Definition | Total percentage change in investment value | Average annual return rate over multiple periods |
| Calculation | Based on initial and final investment values | Derived from multi-year returns, converted to an equivalent annual rate |
| Timeframe Sensitivity | Prone to short-term fluctuations | Smooths out fluctuations over longer periods |
| Interpretation | Provides a snapshot of performance | Offers a standardised measure over time |
| Usage | Useful for short-term assessment and comparisons | Valuable for long-term investment evaluation |
| Negative Returns | Can be negative if the final value < initial investment | It can also be negative, reflecting loss over time |
| Incorporation of Time | Considers only the beginning and ending periods | Accounts for the duration of the investment |
| Flexibility | Less flexible in accounting for periods | Allows for comparison across different timeframes |
| Historical Analysis | Limited insight into long-term performance trends | Provides a clearer picture of investment trends |
| Risk Assessment | Offers limited insight into risk-adjusted returns | Better for assessing risk-adjusted performance |
Absolute Return Vs Annualised Return: How They Impact Investment Decisions?
Using an example, let's understand the impact of absolute and annualised returns. Consider Mr Ram, who invested Rs. 5,00,000 in a mutual fund in 2014. He withdrew after 10 years, and the investment has grown to Rs. 8,00,000.
Now, absolute return = 60% and annualised return = 4.81% (based on the above formulae).
When you see only the absolute return, the 60% return makes the investment more promising. However, the CAGR for this investment is only 4.81%, which is less than the inflation rate. It is less than the returns from fixed deposits. So, even though the investment has grown, it is not the most rewarding investment for Ram.
So, when you compare mutual fund investments, consider the time period of the investment. Focusing on absolute return makes sense for investments of less than one year. However, pay attention to the annualised return for long-term investments because it shows how well the investment has performed despite market volatility.
Conclusion
While using the best app for mutual fund investment, you must consider absolute return vs annualised return. Knowing the differences will help you select the right option based on your investment horizon and risk tolerance. The absolute return shows how much your investment has grown in total. On the other hand, annualised return shows how fast your investment has grown over a given period.
FAQs
- Is annualised return the same as CAGR?
Yes, the CAGR of mutual fund schemes shows how much the fund has grown over a certain period of time. It is the same as an annualised return.
- Why is comparing annualised returns of two mutual fund schemes better?
Absolute return doesn't give you the growth rate of an investment option. It shows how much the investment has grown, regardless of the market conditions. Annualised return gives an overall picture of the gains your investment has made.
- Does absolute return mean fixed income?
No, mutual fund investments cannot guarantee a fixed income. Based on your chosen scheme, your money is invested in multiple asset classes like stocks, bonds, etc. The absolute return simply shows how much your investment has grown.
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