Mutual Fund Returns: Annual Return vs. Annualized Return
When researching mutual fund returns, it’s wise first to understand the distinction between annual return and annualized return. The annual return is the gain or loss of the initial investment over a year. The annualized return is the average rate of return over a multiple-year time frame. For example, suppose you see that a mutual fund had a 15% return last year, and the 10-year historical return is 10%. The previous year’s gain is the annual return, and the 10-year performance is the average return during the period. For some years—during the measured period—the mutual fund may have had large gains, whereas other years, it may have had declines. The average return over the period is annualized.
Calculating Mutual Fund Annual Return and Annualized Return
For a better understanding of a mutual fund’s annual return and annualized return, it’s helpful to know how each is calculated. Keep in mind that a mutual fund’s valuation is not measured in price, unlike stocks and ETFs. Instead, it is expressed as a net asset value (NAV).
Mutual Fund Annual Return Calculation
To find a mutual fund’s annual return—based on the calendar year—you need to find the change in NAV during the year. First, you subtract the beginning NAV on January 1 from the ending NAV on December 31 of the same year. Then you divide that difference in NAV by the beginning NAV. This calculation will give you the annual return, like this: (Ending NAV - Beginning NAV) / Beginning NAV = Annual Return For example, if your beginning NAV on January 1 during a calendar was 100, and the ending NAV on December 31 was 110, your annual return would be 10%, and the calculation would be like this: 110 - 100 = 10 10/100 = 0.10 or 10%
Mutual Fund Annualized Return Calculation
To find a mutual fund’s annualized return, you add the annual returns for every year within a specific time frame, such as three years, five years, or 10 years, and divide the total return by the number of years. For example, suppose you were calculating the three-year annualized return of your mutual fund. The annual returns during the period were 6% in year one, 8% in year two, and 10% in year three. In this case, your three-year annualized return would be 8%, and the calculation would look like this: (6 + 8 + 10) / 3 24 / 3 = 8
Return on Investment vs. Return of Investment
Another important distinction to make when analyzing mutual fund returns, as well as the performance of other investment securities, is the difference between the return on investment and the return of the investment. Return on investment (ROI) is the actual return realized by the investor. Return of the investment is the return of the investment itself. These returns can be different and are often confused. Many investors implement a systematic investment plan (SIP), which means they make periodic investments, such as monthly mutual fund purchases. This system of investing is also called dollar-cost averaging (DCA) and will often make an investor’s ROI different from the stated annual return of the mutual fund. For example, if you use DCA for a stock mutual fund during any given year—and the stock market is crashing during that time frame—your ROI will be higher than the annual return. This result is because the annual return calculates the change in price—NAV, in the case of a mutual fund. It runs from the beginning of the year to the end of the year. However, most investors don’t make a lump-sum investment on January 1. Instead, they make periodic investments throughout the year. When you DCA monthly in a year where the market is crashing, you’ve made purchases every month at progressively lower NAV, which means that any decline in value is not the same as it would be if you had made one lump-sum investment just before the crash began.
Good Average Annual Return for a Mutual Fund
A good average annual return for a mutual fund depends on two primary factors: the type of fund and the historical time frame you are reviewing. When researching mutual funds, it’s wise to review long-term returns, such as the 10-year annualized return, to get a reasonable expectation of future performance. For stock mutual funds, a “good” long-term return (annualized, for 10 years or more) is 8% to 10%. For bond mutual funds, a good long-term return would be 4% to 5%. For more precise, “apples to apples” comparisons, use a good online mutual fund screener. You can then compare any given return for a mutual fund with its category average or against a benchmark index. For example, since its inception in January 1993, the SPDR S&P 500 Index ETF (SPY) has had an annualized return of 9.44%. In terms of performance alone, a stock mutual fund that has long-term returns—such as the 10-year annualized return—that beat this record is considered a good fund. Since its inception in September of 2003, the iShares Core Aggregate Bond ETF (AGG) has an annualized return of 4.29%. A bond fund that has long-term performance that beats this record would be considered a good fund. Correction - July 27, 2022: This article has been updated to correct the equation in the example of a three-year annualized return.
