When we search for best funds in the market we usually notice that 1-year returns of funds are higher than 3-year returns for some funds. Why is it so? How can we expect a fund which gives more return in a shorter period than it gives in a longer period?
This is because of Compounded Annual growth rate which is nothing but average of all those years. Now the question arises why the growth rate is not consistent? Because all of these years they may not have delivered alike. There may be periods when markets deliver lower or even fell down. Suppose funds delivers 15% in the first year, 10% in the second year and 22% in the third year, then its compounded annual return over the 3 years is 15.6% (average returns with compounding).
Let us illustrate further with examples:-
|Scheme Name||Rating||1 Year||3 Years||5 Years|
If you see the above table, the 1-year returns are higher than 3-year returns in both cases. However, the 3-year returns are not the absolute returns, they are annually compounded.
How to calculate the actual returns?
Suppose you have invested a sum of Rs. 1, 00,000 three years ago and another investment of Rs. 1,00,000 one year ago in DEF Fund. Let’s calculate the respective values:
The investment made one year ago would have grown to:
100000 * 1.3864 = 138640
The investment made three years ago would have grown to:
100000 * 1.1761 * 1.1761 * 1.1761 = 162680
We have multiplied it three times because you would have got 17.61% returns in each of the three years, on an average.
But there may be instances where your 1-year return might actually be lower than even your 3-year return. Let’s use another example to understand the whole concept. On 4th January, 2018, the returns of FRANKLIN INDIA PRIMA PLUS FUND were like this and just 6 months ago, on 30th June 2017, the returns looked like this:
|Scheme Name||Dated||1 Year||3 Years||5 Years|
|FRANKLIN INDIA PRIMA PLUS FUND||04th Jan ’18||28.82%||12.21%||18.45%|
|FRANKLIN INDIA PRIMA PLUS FUND||30th June ’17||13.92%||16.14%||19.66%|
The 1-year return at that point was lower. After that, the markets went high, taking top in the fund’s 1-year return. The Sensex also rose 9.9% during this period and similarly fund returns.
So next time you see the shorter period returns to be higher than the longer period returns, know that you are not missing out by investing for the longer period. Shorter period returns look higher when the markets have run up. The longer you invest for, the higher the chances of this volatility getting smoothened out. Next time, be cautious to invest wisely being known of when you require money and all. Just see, if longer period returns have delivered better than benchmark or better than your FDs, then you can go for it. The true story behind any fund can be foreseen with this kind of analysis. I hope every one of you will now see some insights, like this before doing any investments. I shall be deriving such analysis, time to time to make you people aware you the traps of the market and ultimately pave your way to happy investor so as to reap out better returns.