Beginner's guide: How to compare mutual fund returns in India?

Ever felt like you’re drowning in numbers when trying to pick a mutual fund? You log onto a financial portal, see a list of funds, and your eyes immediately jump to that one fund showing “3-year return: 25%!” while another one is at “18%.” Naturally, you think, “Aha! The 25% fund is clearly better.” But hold on a minute. If only it were that simple, right? My name’s Deepak, and with over eight years of advising salaried folks like you on investing, I can tell you that figuring out how to compare mutual fund returns in India effectively is a skill, not just a quick glance at the highest number.

I remember Priya, a software engineer from Pune earning ₹65,000 a month, who came to me totally confused. She’d invested in an ELSS fund that everyone online was raving about for its incredible one-year returns. A year later, her portfolio was just… flat. She felt cheated, but the problem wasn't the fund; it was her approach to comparing it. So, let’s peel back the layers and understand what really matters.

Beyond the "Highest Return" Tab – Decoding Mutual Fund Returns

The first thing to get your head around is that not all "returns" are created equal. When you see a return number, you need to ask: What kind of return is this, and for what period?

Absolute Returns vs. Annualized Returns (CAGR):

• Absolute Return: This is the simplest. It's just the percentage gain or loss over a specific period, regardless of how long that period is. If you invested ₹10,000 and it became ₹12,000, your absolute return is 20%. Useful for periods less than a year.
• Annualized Return (CAGR - Compound Annual Growth Rate): This is your real friend for periods longer than a year. CAGR smooths out the ups and downs and tells you the average annual rate at which your investment grew over multiple years. For example, if your investment grew 20% in one year, then -5% the next, and 15% the third, simply averaging them doesn't give a true picture. CAGR takes into account the compounding effect.

Why is this critical? Imagine two funds. Fund A gives 15% return in 6 months. Fund B gives 25% return in 2 years. Fund A's absolute return looks good for that short period. But if you annualize Fund A's return (assuming it continues at that pace), it’s closer to 30% per annum. Fund B's CAGR is what you'd compare against Fund A's annualized return. Always look for CAGR when comparing funds over periods greater than 12 months. This is fundamental when you're trying to compare mutual fund performance.

The Benchmark is Your Best Friend, Not Just Another Number

Honestly, most advisors won't tell you this in plain English: a fund isn't just competing with other funds; it's competing with an index. This index is called its benchmark. Think of it like a cricket match: your team isn't just playing against another team; it's also measured against some ideal performance standard for that type of game.

When you're evaluating a fund, don't just compare it to other funds in its category. The real test is whether it has consistently beaten its chosen benchmark. For example:

• A large-cap fund should typically be compared to the Nifty 50 TRI or SENSEX TRI (Total Return Index – because it includes dividends).
• A mid-cap fund against the Nifty Midcap 150 TRI.
• A small-cap fund against the Nifty Smallcap 250 TRI.

The AMFI (Association of Mutual Funds in India) has specific categorization rules, and fund houses declare their benchmarks. Always check this! A fund that consistently underperforms its benchmark over 3, 5, or 7 years might not be managed as effectively as you’d hope, even if its absolute returns seem decent. Why? Because you could have invested in an index fund tracking that benchmark and likely done just as well, if not better, after expenses.

Time Horizons and Consistency: It's Not a Sprint, It's a Marathon (with speed bumps)

Remember Priya from Pune? Her mistake was looking only at one-year returns. Mutual fund investing, especially in equity funds, is a long-term game. Looking at just one-year or even two-year returns can be incredibly misleading because markets are cyclical. A fund might have a fantastic year due to a specific sector rally, but then underperform for the next few years.

Here’s what I’ve seen work for busy professionals like Rahul, an IT manager from Hyderabad earning ₹1.2 lakh a month: look at returns across various time frames – 1 year, 3 years, 5 years, and 10 years. What you want to see is consistency. Has the fund managed to stay in the top quartile or at least consistently above its benchmark across these different periods? This shows the fund manager's ability to navigate different market cycles.

Consider a balanced advantage fund. You wouldn’t just look at its performance during a bull run. You’d want to see how it performed during a bear market too. That ability to protect capital during downturns and participate in upturns is key to its consistency. A fund that delivers 14% CAGR consistently over 10 years is often a far better bet than one that jumps to 30% one year and then drops to 5% for two years.

Risk-Adjusted Mutual Fund Performance: It's Not Just How Much You Made, But How You Made It

This is where things get a little more sophisticated, but it's crucial. Imagine two funds, Fund X and Fund Y, both giving you a 15% CAGR over 5 years. Great, right? But what if Fund X achieved that 15% with wild swings – sometimes up 40%, sometimes down 20% – while Fund Y delivered a steady 13-17% every year? Fund Y is likely better, especially for someone who can't stomach huge volatility.

This brings us to risk-adjusted returns. Metrics like Standard Deviation and Sharpe Ratio help us here:

• Standard Deviation: Measures the volatility of a fund’s returns. A higher standard deviation means higher volatility (more ups and downs).
• Sharpe Ratio: This tells you how much return the fund generated for each unit of risk it took, over and above a risk-free rate (like a government bond yield). A higher Sharpe Ratio is better, indicating more return for less risk.

You don't need to be a mathematician to use these. Most financial portals will display these ratios. When comparing two funds with similar returns, always check their standard deviation and Sharpe Ratio. Vikram from Chennai, a senior architect, always prioritizes a fund with a decent Sharpe Ratio, even if its raw returns are slightly lower than a peer, because he values peace of mind.

Expense Ratio and Exit Load – The Hidden Eaters of Your Returns

These are the silent assassins of your portfolio if you're not careful. These fees directly reduce your net returns.

• Expense Ratio: This is the annual fee charged by the AMC (Asset Management Company) to manage your fund. It’s expressed as a percentage of your total investment in the fund. A fund with an expense ratio of 1.5% will deduct 1.5% of your investment value annually. While SEBI caps these, even a 0.5% difference can compound significantly over 10-20 years. Always prefer direct plans over regular plans because they have lower expense ratios (as they cut out distributor commissions).
• Exit Load: This is a fee charged if you redeem your units before a certain period (e.g., 1% if redeemed within 1 year). It's designed to encourage long-term investing. Always check this, especially if you think you might need the money sooner.

A lower expense ratio doesn’t guarantee higher returns, but it certainly helps. Over decades, those percentage points add up to a substantial amount, directly impacting your wealth creation.

What Most People Get Wrong When Comparing Mutual Funds

Let's talk brass tacks about common blunders. I've seen them all:

1. Chasing the "Flavour of the Season": Just because a small-cap fund gave 40% last year doesn't mean it will repeat that, or that it’s right for your risk profile. Markets rotate. What's hot today might be cold tomorrow.
2. Comparing Apples and Oranges: A large-cap fund cannot, and should not, be compared directly to a small-cap fund. Their risk-return characteristics are vastly different. Similarly, comparing an ELSS fund (with a 3-year lock-in) to a liquid fund makes no sense. Always compare funds within the same category.
3. Ignoring Your Own Goals & Risk Appetite: The "best" fund isn't universally best; it's the one that aligns with YOUR financial goals and how much risk YOU are comfortable taking. Anita from Bengaluru, a government employee, wants steady, moderate growth for her retirement. A super-aggressive micro-cap fund, even with stellar past returns, would be a terrible choice for her.
4. Focusing Only on Past Returns: Past performance is an indicator, not a guarantee. While consistency matters, don't blindly assume past winners will continue to win. Fund management teams change, market dynamics shift.

FAQs: Your Quick Guide to Mutual Fund Comparison

1. What is the most important metric to compare mutual fund returns?

For investments longer than a year, the Compound Annual Growth Rate (CAGR) is crucial. But always compare it against the fund's benchmark and consider risk-adjusted metrics like the Sharpe Ratio for a complete picture.

2. Should I always choose the mutual fund with the highest 5-year return?

Not necessarily. While a strong 5-year CAGR is good, you also need to check its consistency across various timeframes, its risk-adjusted returns (Sharpe Ratio), expense ratio, and whether it has consistently beaten its benchmark. A fund with slightly lower returns but better risk management might be a superior choice.

3. What's a "good" expense ratio for an equity mutual fund?

For direct plans, anything below 1% for actively managed equity funds is generally considered good. For passive index funds, it should be much lower, often below 0.3-0.5%. Remember, lower is always better, provided the fund delivers on performance.

4. How often should I review my mutual fund's performance?

For long-term goals, a quarterly or half-yearly review is usually sufficient. Avoid daily or monthly checks, as market fluctuations can cause unnecessary panic. Focus on whether the fund is performing relative to its benchmark and category peers over longer periods (3-5 years).

5. What if my fund is consistently underperforming its benchmark?

If a fund consistently underperforms its benchmark and category peers for 2-3 consecutive years, it might be a red flag. Investigate why: has the fund manager changed? Has the fund's strategy gone off track? If the underperformance persists without a clear reason, it might be time to consider switching to a better-performing fund within the same category.

Phew! That was a lot, wasn’t it? But trust me, understanding these nuances will save you a lot of heartache and help you build a far stronger portfolio than just chasing flashy numbers. The goal isn't to pick the "best" fund, but the "right" fund for you.

Start applying these principles to your current or prospective investments. If you’re planning new investments or want to see how your money could grow over time, check out this handy SIP calculator. It’s a great way to visualize the power of compounding.

Happy investing!

Disclaimer: Mutual fund investments are subject to market risks. Please read all scheme-related documents carefully. This article is for educational purposes only and should not be considered as financial advice. Consult a SEBI-registered financial advisor before making any investment decisions.