A "good" annual return on a mutual fund can only be gauged in a relative sense, influenced primarily by the investment goals of the individual investor and by overall economic and market conditions.
Most mutual funds are aimed at longterm investors, attempting to show relatively smooth, consistent growth levelsÂ with less volatility than the market as a whole. Historically, mutual funds tend to underperform compared to the market average during bull markets, but they outperform the market average during bear markets. Longterm investors usually have a lower risk tolerance and are commonly more concerned with minimizing risk in their mutual fund investments than they are with maximizing gains.
As to what constitutes a good average annual return for a mutual fund, "good" will largely be defined by the individual investor's expectations and desired level of return. Most investors may be satisfied by a return that roughly mirrors the average return of the overall market and consider returns that meet or exceed that goal to constitute a good annual return level. However, investors seeking higher returns would be disappointed by that level of return on investment.
Economic conditions and the performance of the market are also important considerations in determining a good return on investment. For example, if the overall stock market experiences a severe bear market during the year, with stocks dropping on average 10 to 15%, then a fund investor who realized a 3% profit for the year might consider that an excellent return. Under different market conditions, the investor would be very dissatisfied with that same level of return.
Annual Return vs. Annualized Return
To get a clear picture of a mutual fund'sÂ return over time, it's important for investors to understand the difference between annual return and annualized return. Annual return is defined as the percentage change in an investment over a oneyear period; annualized return is the percentage change in an investment measured over periods of time shorter or longer than one year but stated as a yearlyÂ rate of return.
Annual Return
Being able to calculate the annual return of a company or other investment gives investors the ability to analyze performance over any given year the investment is held. The annual return calculation is used more frequently among investors because it is relatively simple compared with annualized return. To calculateÂ annual return,Â first determine the initial price of the investment at the beginning of the time period in question followed the price of the investment at the end of the oneyear period. The initial price is subtracted from the end price to determine the investment's change in price over time.
That change in price is thenÂ divided by the initial price of the investment. For example, an investmentÂ with a stock price of $50 on January 1 that increases to $75 by December 31 of the same year has a change in price of $25. That amount divided by the initial price of $50 results in a 0.5, or 50% increase for the year. Although the annual return provides investors with the total change in price over the oneyear period, the calculation does not take into accountÂ volatilityÂ of the stock price over that time frame.
Annualized Return
In contrast,Â annualized return can be used in a variety of ways to evaluate performance over time.To calculate the annualized rate of return,Â first determine the total return.This is the same calculation as annual return (ending investment price  initial investment price / initial investment price), but is based on the full investment time frame, regardless of whether it's shorter or longer than a oneyear period.
From there, theÂ annualized total returnÂ can beÂ determined by plugging the corresponding values into the following equation: (1+total return)^1/N  1. The variable N represents the number of periods being measured, and the exponent 1 represents the unit of one year being measured. For example, a company with an initial price of $1,000 and an ending price of $2,500 over a sevenyear period would have a total return of 150% (2,500  1,000 / 1,000). The annualized return equates to 13%, with 7 substituted for the variable N: (1 + 1.50)^1/7  1.
The Bottom Line
Before investing in a mutual fund, it's important for investor's to understand their individual goals for the investment over a specific time period. KnowingÂ the expected returnÂ means the investor canÂ measure the mutual fund's performanceÂ over specific time periods andÂ determine whether or not the investment has met their needs.Â

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