Don't be fooled by 'This fund has given 200 per cent returns' headlines

Headlines like, 'This mutual fund has given 200 per cent returns', may sound very cool, but they are likely designed to fool you. Because they are merely using absolute returns metric to write a clickbait article.

Absolute return

• Absolute return refers to the total return a mutual fund has earned over an entire period of time.
  
• For instance, if one invested Rs 10,000 20 years back and has now grown to Rs 2 lakh, the absolute return of the investment would be an incredible 1,900 per cent returns. But this tells only half the story, as the Rs 10,000 investment grew to Rs 2 lakh over 20 years.
  
• Key point: Absolute return is a useful metric for investments less than a year old.

Compound Annual Growth Rate (CAGR)

• CAGR, a fancy way of saying annualised return, measures a fund's yearly return over a long time.
  
• Let's take the previous example where Rs 10,000 fund investment grew to Rs 2 lakh over 20 years. In this case, the annualised return is 16.16 per cent. That's still healthy but far more sobre than a 1,900 per cent absolute return, right?
  
• Moral of the story: Absolute returns should be considered if your investment is less than a year old, whereas CAGR comes in while checking an investment's returns over more than one year.

Extended Internal Rate of Return (XIRR)

• XIRR may sound exotic but it simply measures returns if you staggered your investments over a period of time. SIP is a great example.
  
• While CAGR calculates the annualised returns of a one-time investment, XIRR is a better choice to calculate SIP/SWP (systematic withdrawal plan) returns.
  
• You can find the XIRR return for any fund on this website. All you need to do is type the fund's name on Value Research Online (click on the lens icon on top) and then click on the 'Return' tab. This will be helpful for all SIP/SWP investors.

So far, so good?

Let's now understand trailing return, another metric that measures an investment's performance.

Trailing return

• Trailing return, also known as point-to-point return, calculates returns between two dates.
  
• For example, a one-year trailing return is from August 1, 2023, to August 1, 2024. A five-year trailing return is from June 1, 2019, to June 1, 2024.
  
• Weak point: Trailing return does not convey anything about the consistency or volatility of the fund.

The below screenshot shows the five-year trailing returns of Parag Parikh Flexi Cap Fund, along with its comparison with BSE 500 TRI and an average flexi-cap.

You can find this return metric on Value Research Online. Simply search for any mutual fund of your choice, and then click on the 'Return' tab. You will see the fund's trailing return on the page.

Rolling return

• Rolling return provides a comprehensive view of a fund's performance over time.
  
• To calculate three-year annual rolling returns over 10 years, you would take the following steps:
  
• Calculate the return from Year 1 to Year 3
  
• Then, from Year 2 to Year 4
  
• Continue this process until you calculate the return from Year 8 to Year 10
• Key point: Rolling return shows how consistent a mutual fund has been over a period of time.

The below screenshot shows the five-year annualised rolling return of Parag Parikh Flexi Cap fund. It is a Value Research Premium feature and can be accessed by subscribers only.

Discrete return

• Discrete return is similar to absolute returns. It measures the total return of an investment specific time period like monthly, quarterly, monthly or weekly. On the contrary, absolute return focuses on a fund's total performance over any time period.

Quick recap

• Check an investment's absolute returns if it is less than 12 months old.
  
• Use CAGR (annualised returns) for longer investment periods.
  
• Are you investing in mutual funds through SIP or SWP? Look at the fund's XIRR.
  
• Look at a fund's rolling return to check a fund's long-term performance consistency.

Next time you come across a story claiming incredible returns while scrolling on Google, check which return metric it has used.

Also read: How to statistically analyse funds?