Average Mutual Fund Returns

Average mutual fund returns show how well a mutual fund is performing over a set period of time. This average may be simple or compound. It depends on how the investor wishes to analyze the growth.

The simple average is calculated by taking the percentage of growth for each year and averaging them. This gives a more accurate growth over several years. However, it does not show the growth of the returns.

With a compound average, growth is measured on top of growth. In other words, returns accumulate returns. The average is taken on this total growth.

The SEC uses form N-1A to record these compound averages. This form records this average for one-year, five-year, or ten-year periods. The formula used is:

P(1+T)n = ERV

Where:

P = a hypothetical initial investment of $1,000

T = average annual total return

n = number of years

ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1-, 5-, or 10-year periods at the end of the 1-, 5-, or 10-year periods (or fractional portion).

Many prospectuses use an average to show the strength of any given mutual fund. While it tries to give a fixed percentage of growth, this can often be misleading. For example, if the said fund is to give an average of 10% growth per year for five years, this does not mean that each year had 10% growth. It is only an average.

Another thing to consider is the peaks and valleys hidden within this average. If year one had 40% growth, the second year had 30% growth, the third year had 5% growth, the fourth year had -10% growth, and the fifth year had -15% growth, the average would still be 10%. However, if the investor jumped in during the second year, he would only have an average of 2.5% growth for the last four years.

Mutual fund growth is rarely steady. While it is less affected by market downturns, it is not immune to them. Be aware that no two economic cycles are the same, and, therefore, the average mutual fund returns is only a theoretical indicator of how a fund is performing.