Why the one year returns are higher in mutual funds

Thanks for the kind words about our website which we truly appreciate.

Your assumption about 1 year return being mostly the highest is wrong! Let us see how?

1) You found the one year returns higher as the markets did well in the last one year and so did the fund!. In this case the fund gave 35% return in one year.

2) Any mutual funds research website shows return upto one year in absolute terms. That means if the return is 6% in 6 months, then it is absolute 6%. In your case the absolute return in one year is 35%. However, when the returns above one year is shown, it is annualised. In your case the 3, 5 and 7 year return are 25%, 22% and 20% are annualized . That means the fund gave each year average 25% returns (in case of 3 years), 22% average each year (in case of 5 years) and 20% average each year (in case of 7 years).

3) That means, in case of 5 years the fund gave 140% absolute returns (20% average per annum x 7 years), for 5 years the absolute return is 110% (22% average x 5 years) and for 3 years the fund gave 75% absolute return (25% average annual return x 3 years).

4) Now, let us see what happens if the fund gives 10% return in the 2nd year after giving 35% returns in the 1st year. Therefore, the average returns of 2 years would be 22.5% (35% + 10% / 2) and the absolute return would be 45% (35%+10%)!

5) However, there could be periods when the returns may even be negative during a year. Now suppose, in the 2nd year the return is -10%, then the average return for the period of 2 years would be 12.5% (35% + -10% / 2 ) and absolute would be 25% (35% + -10%).

Hope you can now understand how to read the mutual fund returns and also know why redeeming after 1 year and reinvesting again will not enhance the returns.

Thanks for writing to Advisorkhoj.