How The Average Returns On Mutual Funds Are Calculated

When you invest in a mutual fund, one of the first questions you may ask is: what kind of returns can I potentially expect? To answer that, the first step is to understand how returns are calculated. The term average mutual fund return is widely used, but in fact there are several ways to compute returns, and the choice of method matters. This article explains what tools help you calculate returns online, how total return and average return are worked out, and the key methods used to determine them.

Table of contents

• How can a mutual fund return calculator online help you?
• How does a mutual fund total return calculator work?
• Methods to calculate average returns for mutual funds
• Factors affecting mutual fund returns
• What is the average return of mutual funds?
• Comparison between different approaches
• How to use SIP calculators?

How can a mutual fund return calculator online help you?

Online mutual fund calculators provide a way to estimate how your investment could potentially grow over time. These tools let you enter inputs such as the one-time investment amount or regular contributions (in case of Systematic Investment Plans or SIPs), and the expected rate of return. The calculator then applies formulae to estimate the potential future value of the investment. They simplify the maths and help you compare scenarios.
They may be useful to get a ball-park figure, but actual returns are not guaranteed and depend on market conditions.

The calculator is an aid, not a prediction tool. It may provide only an indicative picture.

Read Also: What is the average maturity period in mutual funds?

How does a mutual fund total return calculator work?

A total return calculator essentially computes how much your investment has potentially grown by the end of the specified period.

For a lumpsum investment, the formula is straightforward: Final value minus initial value divided by initial value gives the absolute return.

For monthly investments (such as an SIP), the calculation is more complex. Each SIP instalment is invested at a different time and therefore grows for a different duration. The calculator typically computes the value of each instalment based on its investment period, sums the future values, and then compares this with the total amount invested. In many cases, SIP returns are calculated using XIRR (Extended Internal Rate of Return), which accounts for the timing of each cash flow.

Luckily, investors have access to numerous free calculators available online that take care of these complex calculations for them and help them compare their options.

Methods to calculate average returns for mutual funds

When evaluating the return on a mutual fund over a given period, investors may commonly use three methods:

1. Absolute Return: This shows the total percentage growth (or decline) of the investment, regardless of how many years it took. It is calculated as

AbsoluteReturn = [(EndingValue−BeginningValue)/Beginning Value]​×100

However, this metric has its limitations – it does not account for the investment horizon or show the annualised return, neither does it account for multiple investments at different times. It simply shows the change in the investment value from point A to point B.

2. Compound annual growth rate (CAGR): This gives the average annualised growth rate, assuming all returns and income were reinvested. The formula is:

CAGR = (Ending Value / Beginning Value) ^ (1 / Number of Years) – 1

This method is suitable for a one-time investment held for multiple years. It smooths out volatility to give the annualised year-on-year return.

3. Extended internal rate of return (XIRR): This method is used when you have multiple cash flows (investments or redemptions) at different dates, typical for SIPs. It takes into account the time and amount of each cash flow and calculates a single annualised rate.

By choosing the suitable method for your investment pattern, you may interpret what an average mutual fund return actually means for your scenario. However, these metrics only measure the returns over a given period. They do not forecast what may happen going forward.

Factors affecting mutual fund returns

Several factors affect the potential returns from a mutual fund, and therefore how the average mutual fund return figure should be interpreted. Here are some of them:

• Investment horizon: For investment horizons of more than a year, Absolute Returns may not provide the whole picture as the metric does not account for time. CAGR may be more suitable.
• Type of investment: Your mode of investment – lumpsum investment or regular contributions (through SIPs) – may affect which method is suitable for you. XIRR may be more suitable than CAGR for SIPs.
• Market performance: The fund’s underlying assets (equities, debt etc.) perform differently in bullish or bearish phases. The average return smooths out volatility to show a single number representing year-on-year growth, but actual returns may have varied during the tenure.
• Fees and expenses: Expense ratios, exit loads and other costs may reduce the net potential return you receive.
• Timing of investments: In SIPs, the date when each instalment is made affects potential returns—XIRR reflects this.
• Reinvestments and dividends: How a fund treats IDCW payouts (whether reinvested or withdrawn) impacts total potential returns.
• Taxation: Capital gains tax impacts the net potential returns realised on redemption, though calculation methods may ignore taxes when computing returns.

What is the average return of mutual funds?

There is no single “average return” for mutual funds because returns vary widely based on the fund category, market conditions, investment horizon, and the strategy followed by each fund. Equity funds, debt funds, hybrid funds, and solution-oriented schemes all behave differently, and even funds within the same category can deliver different outcomes depending on how they are managed.

Instead of focusing on an overall average, investors may assess mutual funds based on their long-term performance consistency, risk profile, asset allocation, and whether the fund aligns with their financial goals. While checking historical returns may provide context, it is important to note that mutual fund returns are market-linked and can fluctuate. Past performance may or may not be sustained in future.

Comparison between different approaches

To illustrate how different calculation methods yield varied results, imagine you invested Rs. 1 lakh lumpsum in a mutual fund five years ago and it has grown to Rs. 1.5 lakh today.

• The absolute return would be (150,000 - 100,000) / 100,000 × 100 = 50 %.
• The CAGR would be [(150,000 / 100,000) ^ (1/5)] - 1 ≈ 8.45 % per annum.

Now, imagine instead that you invested Rs. 2,000 every month for 60 months (i.e., via an SIP) and the final value is Rs. 1.5 lakh.

For the SIP example (₹2,000 every month for 60 months, final value ₹1.5 lakh), the XIRR formula would use each instalment’s actual investment date and the final redemption value to compute the annualised return. The result will differ from CAGR because SIPs involve multiple cash flows at different times, unlike a lump sum investment. CAGR assumes a single investment at the beginning and a single redemption at the end, while SIPs involve regular investments over time. This is why using CAGR for SIPs would not reflect the true return experience, and XIRR is the appropriate measure for SIP returns.

To calculate XIRR, in Excel, list all the SIP instalments and the final value. Then, use the formula =XIRR(values,dates, guess). The total, in this case, comes to approximately 8.84%.

So, when comparing two funds or two ways of investing, you’re advised to compare like with like: same investment pattern and same method of calculating the average mutual fund return.

The figures shown are for illustrative purpose only

Read Also: Average Return on SIP: Factors and Strategies for Maximising Potential Returns

How to use SIP calculators?

When you use an SIP calculator, you input: monthly investment amount, expected rate of return, investment tenure, and whether the contribution might increase over time. The calculator then estimates future value based on compounding monthly. It often also computes what the equivalent annualised return (approximate) would be.

You may experiment, alter the monthly amount, change the tenure, tweak the assumed rate of return, and see how even modest changes in return rate or tenure may affect the potential future value significantly.

Just remember: the number you get from an SIP calculator is an estimate based on assumptions. The average mutual fund return you input is not guaranteed – it is only a helpful benchmark for planning and actual performance is market-linked. The calculator is an aid, not a prediction tool. It may provide only an indicative picture.

FAQ

What is the difference between Absolute Return and Annualised Return in mutual funds?

Absolute return is simply the percentage gain or loss of an investment over the entirety of its investment period, without regard for how long that period is. Annualised return spreads the return over each year of the investment period, showing an average per-year rate. For multi-year investments, annualised returns may give a clearer view of pace of growth.

How is the Compound Annual Growth Rate (CAGR) calculated for mutual fund investments?

The formula is:

CAGR = (Ending Value / Beginning Value) ^ (1 / Number of Years) – 1

where n is the number of years the investment was held.

What is the Extended Internal Rate of Return (XIRR), and how does it differ from CAGR?

XIRR is a method that calculates the annualised rate of return taking into account multiple cash flows made at different dates, such as monthly SIPs, redemptions or interim withdrawals. CAGR, on the other hand, only uses one initial investment amount and one final value after n years. Because XIRR considers the timing and amount of every contribution, it is considered more suitable for recurring investments.

Why is it important to understand the different methods of calculating mutual fund returns?

The average mutual fund return may vary depending on how it is calculated and what investment pattern was used. For example, a lumpsum investment calculated using CAGR will show different results compared to an SIP investment measured with XIRR.

Choosing the suitable calculation method helps interpret the return figure correctly and compare funds or strategies with more detailed information.