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Check the Causes of Diminishing Mutual Fund Returns

Created on 16 Dec 2019

Wraps up in 5 Min

Read by 2.8k people

Updated on 01 Aug 2021

investor getting returns out of investment in mutual funds

I remember when I was in school; there was a trend of mutual funds in my neighbourhood. People were always talking about their mutual fund returns like I'm getting this much mutual fund returns on this scheme or that scheme. Now at that time, I didn't know much about mutual fund returns, but I deduced that mutual fund returns and mutual fund itself must mean something like "money earned from a group of people."

However, our concern in this article is: "Is there a way to maximize our mutual fund returns?"

To answer this question, we'll first discuss what a mutual fund is and what precisely mutual fund returns are. The most interesting part uncovered in the later part of this blog is the causes of diminishing Mutual Fund Returns. 

So, Let's begin...

What is Mutual Fund?

A mutual fund is basically an investment, which is made by a group of professional investors. These investors can be retail or institutional. The investors pool their money and invest in bonds, stocks, and various other securities or assets.

Each investor in a mutual fund is liable to both profit and loss generated by the investment. Although mutual fund investment may seem similar to an investment in stock, yet there is a precise difference between them. There are no voting rights provided to investors when they invest in a mutual fund.

The so-called ‘professional investors’ in our definition above, is generally people in a mutual fund company, and we are the fuel for their investment vehicle. When we invest in a mutual fund, we actually buy some fraction of its portfolio and, unlike stocks whose price fluctuates in real-time; Net Asset Value (NAV) decides the price of a mutual fund.

NAV is calculated as the difference between the total value of assets and the total value of liabilities. NAV thus represents the net capital earned by the mutual fund company. In the case of mutual funds it is calculated using this simple formula:

NAV =  (Assets - Liabilities)/ Total number of Outstanding shares,

where the term ‘Outstanding Shares’ refers to stocks held by the company's shareholders.

Now that we covered the basics of a Mutual Fund, let's talk about Mutual Funds returns.

Mutual Fund Returns

First, let's talk about 'return' in the context of investment. A return is just the money made or lost on an investment. However, this definition is more suitable for prudent investors. Colloquially return is defined merely as the gain we earn from an investment. Mutual fund returns are affected by various factors like economic and marketing conditions (i.e., whether the market is bull or bear), and expectations of investors.

Although mutual fund investment may seem similar to an investment in stock, yet there is a precise difference between them. There are no voting rights provided to investors when they invest in a mutual fund.

The investors in either of the following ways earn mutual fund returns:

  • Mutual fund returns are earned in the form of dividends (a portion of the company's gains) to the shareholders (us).
  • Mutual fund returns are earned in the form of interest in bonds (basically a type of loan mutual fund companies give out to an entity).
  • Shareholders may also reinvest their mutual fund returns to buy more stocks if they wish to do so.
  • Mutual fund returns are earned in the form of distributions (a payout of cash or stocks in case of mutual funds) if the mutual fund company has made a capital gain (only net profit) by selling its securities (financial assets like stocks).
  • Mutual fund returns can be earned by selling our shares in the market to earn a profit if the fund's shares reach an optimum price.

Systematic Investment Plan (SIP) Mutual Fund

SIP Mutual Fund is a great scheme for retail investors (common people), which allows periodic investment (like yearly, monthly, weekly). SIP creates wealth for us in the long term, and offers a reduction in market risks, as compared to other schemes. Furthermore, SIP is highly flexible, thus allowing investors to update, create, or cancel their scheme anytime they want.

Finally, funds in SIP Mutual Fund start from as low as Rs. 1000, so it is ideal for small investors.

Mutual fund returns of SIP are calculated by the use of SIP calculator, which uses the following formula:

FV = Px({[1+i]n - 1} / I) x (1 + i ).

Where FV is the future value (Value earned at the end)

P is the SIP amount you invest
‘n’ is the tenure of investment like 12 months   
‘i’ is the annual rate of return you expect(in percentage).

 Now 'i' is compounded annually, so if you invest monthly, then i= i/12, or if you invest daily, then i= i/365.

To avoid these calculations, you can simply make use of the SIP calculator, which is available on our website.

Things Diminishing your Mutual Fund Returns

Sometimes to avoid something, we first need to analyze its cause. So, let’s look at the ‘cause’ of diminishing mutual fund returns:

  • Expense Ratio :

It is defined as the cost that investors need to pay for a company’s operating expenses, like legal costs and fund management. Mutual fund companies usually justify the need for a higher expense ratio, saying that it'll help them to perform well in fluctuating markets. However, the higher expense ratio is also prone to reduce your mutual fund returns. To avoid these, invest in a mutual fund company that has an optimum expense ratio (say about 0.5%).

  • Portfolio Turnover:

Portfolio Turnover identifies the pace at which securities are traded by the mutual fund’s managers over a given time. It is measured in the portfolio turnover ratio (percentage change in the portfolio in one year). Higher turnover means increased expenses, which can minimize the fund's performance. Furthermore, if the fund’s performance is lagging and still the portfolio turnover is higher, then it is certainly a bad sign for the investor. Thus, both the performance of the company and optimum portfolio turnover is necessary for good mutual fund returns.

  • Exit Load:

It is the fee that mutual fund companies charge you while you exit a scheme early. It is advised that you should try to avoid exit load as they can greatly affect your mutual fund returns. However, if you've got no option but to exit the scheme early, the impact of exit load must be considered.

  • Taxes:

Finally, do consider the impact of various taxes imposed on your mutual fund returns through dividends, distributions, etc. You'll receive your returns after various kinds of taxes are imposed on them.

Denouement

All of us must've heard a guy speaking in light speed on our Televisions: "Mutual funds investments are subject to market risk."Well, he is right mutual funds are a risky business, but only if you invest unwisely. Hence, consider analyzing the details of a mutual fund company and pay attention to the scheme policy before investing.

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Rishika Mukherjee

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Mukherjee is an avid reader and loves to write as much as read. She is the youngest of all but handles chores like a 50-year-old woman. She takes a lot on her plate and somehow, eerily manages to get the job done. As Hazel Grace stated, she could read a good author's grocery list, and so would Miss Mukherjee. 

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