How Much of an Annual Return Should a Mutual Fund Expect?

Mutual Fund Average Returns: Annual vs. Annualized Returns

The answer will depend on a few critical elements if you want to know an excellent annual return for a mutual fund. These variables include the type of fund and the length of time (horizon) over which you plan to invest. An excellent annual return, for instance, is anticipated to be much higher for a stock mutual fund than a bond fund.  

Main Points:

  • Teach yourself the differences between "return of investment" and "return on investment."
  • A mutual fund's "good" annual return is influenced by the type of fund and the investment's time horizon.
  • You can better understand a fund's performance by distinguishing between "annual return" and "annualized return."

Annual Return vs. Annualized Return for Mutual Funds

It's prudent first to comprehend the difference between annual and annualized returns when looking into mutual fund returns. The gain or loss of the initial investment over a year is the annual return. The average rate of return over several years is known as the annualized return.   Imagine, for instance, that you discover a mutual fund's return for the previous year was 15% while the 10-year historical return is 10%. The annual return equals the gain from the prior year, and the 10-year performance is the average return. The mutual fund may have experienced significant gains in some years during the measured period while experiencing losses in other years—the annualized average return for the period.  

Calculating the Annualized Return and Annualized Return of Mutual Funds

Understanding how each is calculated will help you comprehend a mutual fund's annual and annualized returns. Remember that, unlike stocks and ETFs, the valuation of a mutual fund is not determined by the price. Instead, a net asset value is used to express it (NAV).  

Tip:

A mutual fund's net asset value is the sum of its holdings' value less its liabilities. It is determined each day at the close of trading using the closing market prices of all the fund's securities.

Calculating the Annual Return of Mutual Funds

It would be best if you determined the change in NAV over the year to calculate a mutual fund's annual return based on the calendar year. The starting NAV on January 1 is subtracted from the ending on December 31 of the same year. The difference in NAV is then divided by the starting NAV. You can calculate the annual return using the formula below:   Annual Return = (Ending NAV - Beginning NAV) / Beginning NAV   Your annual return would be 10% if, for instance, your beginning NAV on January 1 during a calendar year was 100 and your ending NAV on December 31 was 110. The calculation would be as follows:   110 - 100 = 10   10/100 equals 0.10, or 10%  

Calculating the Annualized Return of Mutual Funds

The annualized return of a mutual fund is calculated by adding the annual returns for each year over a predetermined period, such as three, five, or ten years, and dividing the total return by the number of years. Consider the situation where you figured out your mutual fund's three-year annualized return. During that time, the annual returns were 6 percent in year 1, 8 percent in year 2, and 10 percent in year 3. Your three-year annualized return would be 8% in this case, and the calculation would be as follows:   (6 + 8 + 10) / 3   36 / 3 = 8  

Tip:

The gain or loss of specific investment security over a year is the annual return. The average return on investment over several years is the annualized return.  

Comparing returns on investment and returns on capital

The distinction between return on investment and return of investment is another crucial factor to consider when examining mutual fund returns as well as the performance of other investment securities. The investment's return is the return on investment. The actual return the investor realizes is known as return on investment (ROI). These returns can vary and are frequently misunderstood.   Many investors use systematic investment plans (SIPs), which involve regular investments like buying mutual funds every month. This method of investing, also known as dollar-cost averaging (DCA), frequently causes an investor's ROI to deviate from the mutual fund's declared annual return.   When using DCA for a stock mutual fund, for instance, during a year when the stock market is in a bear market, your ROI will be higher than the annual return. This outcome results from the annual return's calculation of the price change, or in the case of a mutual fund, NAV. It lasts all year long, from start to finish. But most investors don't make a one-time, significant investment on January 1. Instead, they invest occasionally over the year.   In a year when the market is collapsing, when you DCA monthly, you have made purchases at progressively lower NAVs, so any value decline is not the same as if you had made one lump-sum investment right before the crash started.  

Good Mutual Fund Average Annual Return

The type of fund and the historical period you are looking at are the two main factors determining an effective average annual return for a mutual fund. To get a reasonable idea of future performance when researching mutual funds, it is advisable to look at long-term returns, such as the 10-year annualized return.   An "acceptable" long-term return (annualized, for 10 years or more) for stock mutual funds is between 8% and 10%. An excellent long-term return for bond mutual funds would be between 4% and 5%. Use an excellent online mutual fund screener for more accurate "apples to apples" comparisons. Can then compare the mutual fund's return to an index or the average for its category.  

Tip:

When a fund can outperform a benchmark index (or a fund that tracks a benchmark index) for ten years or more, that is one indicator of good long-term performance. A stock mutual fund with long-term returns surpassing this benchmark, such as the 10-year annualized return, is regarded as a good fund in terms of performance alone. The SPDR S&P 500 Index ETF (SPY), for instance, has generated an annualized return of 9.44 percent since its launch in January 1993. The iShares Core Aggregate Bond ETF (AGG) has returned 4.29 percent annually since its founding in September 2003. A bond fund outperforming this benchmark over the long term would be considered a good fund.  

Frequently Asked Questions (FAQs)

How do I make a mutual fund investment?

You'll need a specific financial account to invest in mutual funds, typically a brokerage or retirement account. Although opening these accounts is similar to standard checking or savings accounts, they are not the same. You only need to place a buy order for the mutual fund you want to invest in after the account has been opened.  

Tax treatment of mutual funds

Like stock taxes, mutual fund taxes apply to dividend distributions and capital gains on the sale of fund shares. By selling stocks from the portfolio, a fund manager may impose capital gains on the fund; however, will deduct those taxes from your distributions, so you don't need to take any additional steps to determine your tax liability for that activity.  

How are mutual funds profitable?

Management fees are deducted from mutual funds annually to cover operating expenses. The expense ratio, which reveals how much each dollar invested is paid to fund managers, can determine how much a mutual fund charges investors.

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