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.
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.
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
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.
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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.
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.
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Bottomline
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.