Stocks, gold, mutual funds, or any other investment, all of us invest to earn good returns. Thus, the first thing that we typically search for in any investment product is how much return it has given in the past. However, there are different ways of looking at return on investment. For instance, you must have come across different terms like Trailing Returns, Rolling Returns, Annual Returns. If you don’t understand what all these different types of returns signify about an investment product, you can never make an apples-to-apples comparison to select the best investment options.
Thus, in this blog, we will explain the 3 most commonly used ways to measure a product’s returns: annual, trailing, and rolling. We will explain what each of them means and in what ways they are different from one another. Finally, we will explain how you should read these 3 types of returns to make the most of your investments.
Annual Returns
The annual return of an investment product shows its performance for the calendar year. So you can check the consistency in the performance of an investment product if you check the annual returns year after year. And the best part is that the annual return calculation is a fairly simple process.
You need to find the investment price (or NAV of a mutual fund scheme) at the end of the current calendar year and the previous calendar year. Next, subtract last year’s price from the current year’s price. Then divide the change in price by the last year’s price.
For example, let’s calculate the annual return of the Nippon India Small Cap Fund in 2021.
Annual Return = (NAV on Dec 31, 2021 – NAV on Dec 31, 2020)/ NAV on Dec 31, 2020
NAV On Dec 31, 2020 Rs. 54.54 NAV On Dec 31, 2021 Rs. 94.97 Difference in NAV Rs. 40.43 Annual Return From Nippon India Small Cap Fund in 2021 74%
Following this method, you can determine the annual return of any investment product year after year. Let us extend the above example and illustrate how the annual returns can give you a fair idea about a mutual fund scheme’s performance.
The following table shows the annual returns of the Nippon India Small Cap Fund over the last 5 years.
Year Annual Return Of Nippon India Small Cap Fund Small Cap Fund Category Average NIFTY SmallCap 250 TRI 2017 64.41% 56.26% 57.07% 2018 -15.61% -17.69% -23.62% 2019 1.19% -0.32% -3.95% 2020 30.88% 32.05% 26.32% 2021 74.36% 65.25% 61.44%
Looking at the year-on-year returns, you can get some idea about the consistency in a fund’s performance and can also gauge the volatility across various market scenarios.
Moreover, comparing these year-on-year annual returns with a scheme’s benchmark or its category average will give you a better idea about the fund’s performance. In the above example, the Nippon India Small Cap Fund has outperformed its benchmark in all 5 years. It has also beaten the category average in 4 out of 5 years. So these data points are a good sign for a fund’s performance.
Limitations Of Annual Returns
The annual return has some limitations as well. For instance, a fund could beat its benchmark for most years. Yet, the fund could be underperforming during the overall period under observation. It happens because you are looking at multiple years of annual returns. And it is difficult to estimate net returns over a period.
Simply put, multiple years of annual returns do not show the impact of compounding. So you do not get to see the return a fund has accumulated over the period.
Let’s understand this limitation with an example. Say a fund has performed in the following manner against its benchmark.
Year Fund Return Benchmark Return 2015 10% 9% 2016 4% 3% 2017 -12% -8% 2018 -23% -7% 2019 14% 11% 2020 16% 12% 2021 37% 4%
On the face of it, you see that the fund has beaten its benchmark in 5 out of 7 years,i.e., 2015, 2016, 2019, 2020 and 2021. So your first impression is that the fund should have outperformed its benchmark. But when you calculate the return, the fund is actually underperforming its benchmark.
If you had invested Rs. 100 in the fund at the start of 2015, it would have grown to Rs. 141 by 2021. On the other hand, if you had invested in the benchmark index, the same Rs. 100 would have grown to Rs.160 by 2021.
Therefore, annual returns do not show a clear picture while comparing the net returns of multiple investment instruments over a long period. And this is where trailing returns come into the picture.
Trailing Returns
Trailing return helps you measure the average annual return between two dates. So we use the compounding formula to calculate this return.
Trailing Returns = (Current Value/Starting Value) ^ (1/Trailing Period) – 1
Let’s understand with an example.
Say, today’s date is January 3, 2022. You want to check the 3-year trailing return of the Parag Parikh Flexi Cap Fund. Here’s how the trailing return calculation works:
NAV on Jan 3, 2022= 54.58
NAV 3 years ago, i.e., NAV on Jan 3, 2019 = Rs. 24.01
Absolute Return = (54.58 – 24.01)/(24.01) = 127.32%
3-year Trailing return = {(54.58/24.01)^(⅓)} – 1 = 31.49% (Using compounding formula)
As you can see in the example, the trailing return shows a return between two dates. Due to this, comparing returns from two funds or finding the return over a period becomes easy.
For example, here are 10-year trailing returns of multiple funds.
Fund Name 10-year Trailing Return* Aditya Birla Sun Life Tax Saving Fund 14.95% HDFC Taxsaver 12.83% Quant Tax Plan 19.84%
*Trailing return as of Mar 30, 2022
From this table, it is quite clear that the Quant Tax Plan has given the highest return in the last 10 years among the 3 funds. And HDFC Taxsaver has given the lowest returns. However, had we checked the annual returns of these 3 funds, we couldn’t have arrived at this conclusion about returns very easily.
Nonetheless, the trailing return also has certain limitations. Let’s understand these limitations.
Limitations Of Trailing Returns
Trailing returns measure performance for just one block of time and show a point-to-point return. Thus, the trailing return of a fund doesn’t necessarily show the consistency or volatility of a fund.
For example, if two funds have similar returns, you cannot find which one is the more volatile fund. Let’s understand with an illustration.
As the graph shows, the problem with trailing returns is that it does not show the volatility of a fund. In the above example, both the funds have delivered a 10% average annual return over the last 10 years, with one fund being more volatile than the other. But only looking at the 10% trailing return would never give you any idea about the volatility in both the fund’s past performance.
Moreover, depending on when you are investing and withdrawing, your trailing return can change significantly. That is because of the nature of equity markets. As markets keep moving up and down, there is a possibility that you may enter during a rally and then exit during a correction or vice versa.
For example, say you invested in SENSEX for a 10 year period. Depending on the date of investment and redemption, your returns may vary.
Here is a table that shows some arbitrarily taken 10-year investment periods and the various possible returns in that period.
Investment date Withdrawal date Tenure Average Annual Return Oct 30, 2001 Oct 30, 2011 10 years 19.5% March 30, 2010 March 30, 2020 10 years 5.3% March 30, 2011 March 31, 2021 10 years 9.8% June 30, 2008 June 30, 2018 10 years 10.2% May 30, 2008 May 30, 2018 10 years 7.9% February 1, 2009 February 1, 2019 10 years 14.9%
As you can see, the returns will vary depending on which 10 year period you invested for. Your returns can vary significantly depending on your entry and exit date. As trailing returns give you get point-to-point returns, you wouldn’t know how the fund has performed for a different 10-year period. To overcome this challenge, you need to find out the possibilities of earning good returns for staying invested for a specific period. To that end, the rolling return can be the solution.
Rolling Returns
Rolling return is calculated for a particular period on a continuous basis (or fixed frequency). Simply put, it is like calculating trailing returns on a daily basis.
Let’s understand with an example. Suppose we want to see the 5-year return of a fund over the 10 year period between 2010 to 2020. So, the rolling return would mean calculating the 5-year return on each day during this period.
You will calculate the 5-year return as on 1st January 2010, 2nd January 2010, and so on till 31st December 2020. It will show you a spread of returns had you invested on any day during this period (2010 to 2020) for a 5 year period.
One of the biggest advantages of rolling returns is that by looking at the range of returns, you can understand what kind of returns the fund has delivered for the period you are planning to invest in it. And in some way, you can understand the probability of earning such returns going forward.
Let’s understand with an illustration.
Say you want to invest in a NIFTY 500 index fund. But you are not sure what kind of returns you should expect from your investment. Looking at rolling returns will give you a realistic and comprehensive picture of what kind of returns you can expect.
Here’s a table that shows the rolling return of the NIFTY 500 index for several periods.
Return Consistency (% of times) Investment Period Less Than 0% Return 0-8% return 8-12% return More than 12% return 1 year 22.30% 14.60% 8.50% 54.60% 3 years 10.70% 20.50% 12.90% 55.90% 5 years 1% 17.10% 20.90% 61% 7 years 0% 6.10% 24.50% 69.40% 10 years 0% 4.40% 29% 66.60% 15 years 0% 0% 10.60% 89.40%
As you can see, the rolling returns table gives you a fair idea about the probability of earning a certain percentage of returns.
For instance, from the above table, it is clear that investors who stayed invested for 15 years have had better chances of earning more than 12% returns than those investors who stayed invested for a short period of 1-3 years.
When someone stayed invested for more than 15 years, they earned more than 12% returns almost 9 out of 10 times. But for investors who stayed invested for only 1 year, the instances of earning more than 12% was only 55%.
We have a detailed blog on rolling returns that explains the concept with illustrations and shows how it can help you analyze the performance of different investment products better.
Annual Return Vs Trailing Return Vs Rolling Return – Which Return Should You Look At?
All three types of returns – annual, trailing, and rolling – stand out on different fronts. So they can be useful for different purposes. For instance, annual return and rolling return can be useful to gauge the volatility or consistency in a fund’s performance. The trailing return may not show these aspects, but it is useful to show the compounding effect on returns.
To sum up, no single return should be your sole focus as an investor. Narrowly focusing on the rolling, trailing, or annual returns would mean you are losing sight of the big picture. Ultimately, you need to consider annual, trailing, and rolling returns to make prudent investment decisions.