Average Rate of Return on Mutual Funds: Types And Factors That Affect Returns
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5 May 2022Average returns of a mutual fund helps assess the funds’ long-term performance. Over the years, mutual funds have become a popular mode of investment. In India, there are many types of mutual funds that cater to various needs of the investors. The performance of these funds depends on factors like, economic conditions and market fluctuations. Investors can compare mutual fund returns to the index benchmark.
Knowing the average returns of mutual funds can be helpful in taking the right investment decision. Read on to know how mutual fund returns work, types of mutual fund returns, average returns of mutual fund and factors that affect them. Read on!
Table of contents
Understanding Rate of Return on Mutual Fund Investment
A mutual fund invests in a basket of securities based on the scheme’s investment objective. This can include stocks, money market instruments, bonds, government securities, etc. The performance of these securities affects the fund’s performance.
When looking at a mutual fund’s performance, you should look at its long-term performance instead of short-term fluctuations. The average returns of a mutual fund show the simple mathematical average of its returns over time. Besides this, you will want to check its performance against its benchmark over a period.
When looking at a mutual fund scheme’s performance, it is a good idea to not look at its annualised returns in isolation. For example, if a mutual fund shows 10% annualised returns but its benchmark is much higher, it may not be the right investment. You will also want to examine a fund’s category average returns to find out if there are better schemes in the peer group.
For example, a mutual fund ABC invests 80% of its assets in equities and 20% in debt instruments. If the stock market crashes, its NAV (Net Asset Value) would most likely plummet as the value most of its underlying assets (stocks) would decrease.
The NAV of mutual funds tends to go up or down, depending on the price or interest rate of securities. Various important factors, including government policies, currency exchange rates, interest rates, taxation policies, etc., impact the performance of mutual fund schemes.
Types of Mutual Fund Returns
There are several methods of calculating the average rate of returns on a mutual fund. Some of these are as follows:
- Absolute returns: In absolute or point-to-point returns, gains are calculated between the starting date and the redemption date of funds. You should use this value when the holding period is less than a year.
- Annualised returns: Annualised returns help to calculate the rate of return over the entire investment period, irrespective of whether it is shorter or longer than a year. It shows a much-smoothened rate as it considers the compounding effect of interest rate.
- Rolling returns: This refers to a fund’s annualised returns for a certain period, which can be daily, weekly or monthly. To know the rolling returns, you have to measure the fund’s absolute and relative returns over blocks of 3, 5 or 10 year periods.
- Total returns: The total returns refer to the actual gains that you got from your investment. It includes both the capital gains from the mutual fund and dividend income.
- Trailing returns: In this method, you calculate the returns from historical data over a specific trailing period, for example, 1 year, 3 years, and so on. You can calculate this in an MS Excel spreadsheet using the XIRR (Extended Internal Rate of Return) function.
Average Rate of Returns on Different Types of Mutual Funds
The following are the different types of mutual funds based on the underlying asset class and their average returns.
- Equity funds
These mutual funds invest primarily in stocks and equity-related instruments. Equity funds offer the possibility of the highest returns among mutual funds depending on the market performance but also carry the highest risk.
The 3-year average returns of these mutual funds range from 14.19% (large cap funds) to 26.6% (small cap funds) as of May 2 2022.
- Debt funds
Debt mutual funds invest in fixed-income instruments like treasury bills, debentures, government securities, corporate bonds, and money market instruments. Conservative investors looking for stable returns prefer such funds.
As of May 2022, the 3-year average return of debt funds (credit risk funds) is 3.89%.
- Hybrid funds
Investors looking for decent returns with moderate risks prefer hybrid mutual funds. Hybrid funds invest in a mix of equities and debt instruments.
The 3-year average returns of such mutual funds range from 8.24% (equity savings funds) to 13.24% (multi asset allocation funds) as of May 2 2022.
If you wish to start investing in mutual funds, visit Navi Mutual Fund and explore the different options. After you choose a scheme, you can start investing in it with an amount as low as Rs. 500.
Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
Also Read: Things To Know Before Choosing A Mutual Fund Scheme In India
Factors That Affect the Average Rate of Return on Mutual Funds
Here are some of the factors that have a significant impact on the average returns of mutual funds:
- Economic factors: Macroeconomic factors like government policy, geopolitical events, etc., have a significant impact on a mutual fund’s returns. For example, a favourable government policy in a sector could see the stock prices soaring.
- Performance of the fund manager: The fund manager and his/her team of experts are responsible for managing investors’ money and finding suitable investment options. Their research and fund selection has a significant impact on a fund’s performance.
- Expense ratio: All fund houses charge an expense ratio that contains all the fees related to operating a mutual fund. A higher expense ratio can cut into your returns, especially in the case of long-term investments.
- Cash flows of the fund: Since a mutual fund collects money to invest, more investment would result in more cash for portfolio diversification. However, if many investors exit their investments, the fund manager will have to sell a large part of the holdings, which would negatively impact the NAV of mutual funds.
Also Read: 10 Best Index Funds In India (2022): Benefits, Taxation & Who Can Invest
Final Word
The average returns of a mutual fund tell you how much gains the scheme accrued over time. Returns over the short term do not accurately reflect a fund’s performance. Thus, you should look at a fund’s long-term returns and compare them against its benchmark and competitors. However, it is important to remember that a fund’s past performance is not an indicator of its future returns.
FAQs on Average Rate of Return on Mutual Funds
Ans: A fund with a high AUM has more cash flow, and thus, it should perform better than smaller funds. However, if a fund’s corpus becomes too large, the fund manager might not be able to manage the funds efficiently.
Ans: Alpha is a parameter that tells you the fund manager’s contribution. It measures a fund’s performance as a result of stock selection. It is by calculated by subtracting the actual returns from the expected returns while taking into account its beta (measure of a fund’s volatility relative to its benchmark index).
Ans: The risk-adjusted return of a mutual fund is given by its Sharpe ratio, which signifies a fund’s returns against its risks. Mutual funds generating high returns with low risks associated are the most sought-after among investors.
Ans: Yes, capital gains from mutual funds are subject to taxes, depending on the holding period of investment. In the case of equity-oriented funds, for a holding period of 12 months or more, long-term capital gains (LTCG) are taxed at 10%. Short-term capital gains (STCG) tax is applicable at a 15% rate for a holding period of less than 1 year.
For other types of mutual funds, STCG tax is applicable for a holding period of fewer than 36 months at the relevant tax slab rates. Lon term capital gains are taxed at 20% with the indexation benefit.
Ans: The exit load is a charge applicable if you sell your fund units within a particular period. Most fund houses charge an exit load if you redeem your funds before a year. In India, fund houses can only charge an expense ratio and an exit load but not an entry load.
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