If you want to know what a good annual return for a mutual fund is, the answer will depend on a few primary factors. These factors include the type of fund and the time frame or horizon of your investment. For example, a good annual return for a stock mutual fund is expected to be much higher than that of a bond fund.
Key Takeaways
- A "good" annual return for a mutual fund depends on factors such as the type of fund and the time frame or horizon of the investment.
- Knowing the difference between "annual return" and "annualized return" will help you understand a fund's performance.
- You should also learn about "return on investment" vs. "return of investment."
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).
Note
Net asset value is the total of the value of a mutual fund’s holdings, minus its liabilities. It is calculated daily, at the end of trading, based on the end-of-day market price of each security in the fund.
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 thebeginning 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
Note
The annual return is simply the gain or loss of particular investment security during a calendar year. The annualized return is the average return for an investment for a multiple-year time frame.
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.
Note
One measure of what determines good long-term performance is when a fund can beat a benchmark index (or a fund that tracks a benchmark index) for 10 years or more.
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.
Frequently Asked Questions (FAQs)
How do I invest in mutual funds?
You'll need a special type of financial account to invest in mutual funds, usually either a brokerage account or retirement account. These accounts are different from standard checking or savings accounts, but the process of opening them is similar. Once you've opened the account, you just need to place a buy order for the mutual fund you want to invest in.
How are mutual funds taxed?
Mutual fund taxes are like stock taxes; the two types of taxes that apply are capital gains when you sell fund shares and taxes on dividend distributions. A fund manager may impose capital gains on the fund by selling stocks from the portfolio, but those taxes will be taken out of your distributions, so you don't have to take extra steps to calculate your tax burden for that activity.
How do mutual funds make money?
Mutual funds take out management fees every year to pay for the costs of operation. You can learn how much a mutual fund charges investors by looking up the expense ratio, which tells you how much of every dollar invested is paid to fund managers.
Correction - July 27, 2022: This article has been updated to correct the equation in the example of a three-year annualized return.
