Annual vs Trailing vs Rolling Returns Explained

Returns are a way to evaluate the profitability of an investment over a period of time. There are several methods of measuring returns, including simple returns, annualised returns, total returns, risk-adjusted returns, and relative returns.

Annual, trailing, and rolling returns are different ways to measure investment performance over time. Each of these metrics has its advantages and disadvantages, and they can be used to provide different insights into an investment's performance, including those in compounding mutual funds and other forms of mutual funds. 

Annual return

Annual returns are a widely used metric to evaluate investment performance, expressing the percentage change in an investment's value over one year. To calculate annual returns, one must subtract the beginning value from the ending value, and then divide it by the beginning value, and multiply by 100 to get the percentage return. 

Let's say your NAV of a mutual fund as on 31 March 2022 increased from ₹34 to ₹50 in a year’s time. To calculate the annual return:

Annual return = (NAV on Mar 31, 2022 – NAV on Mar 31, 2021)/ NAV on Mar 31, 2021) *100

AR= (50-34)/34 *100

AR= 47%

Annual returns offer a quick snapshot of investment performance and can be beneficial to compare different investments over a year. It is important to note that annual returns can be volatile and fluctuate with market conditions, and investors should not rely solely on annual returns to make investment decisions. Instead, they should evaluate multiple factors such as risk, diversification, liquidity, and other types of returns, such as total returns and risk-adjusted returns, before making investment decisions.

Rolling returns 

Rolling returns offer an alternative approach to measuring investment performance over a specific period, such as one, three, or five years. Unlike annual returns which only provide a snapshot of performance for a single year, rolling returns provide a more comprehensive view of how an investment has performed over multiple periods.

To calculate rolling returns, an investor selects a specific time frame (e.g., three years) and a starting point (e.g. January 1st). The investor then calculates the investment's return over the chosen time frame, moves the starting point forward by one day or month, and recalculates the investment's return over the same time frame. This process is repeated until the investor has calculated the investment's returns over every possible time frame.

For instance, suppose an investor wants to evaluate three-year rolling return for an investment in a mutual fund from 2008 to 2018. We will start calculating the return from 1 January 2008 to 1 January 2011. The next date will be 2 January 2008 to 2 January 2011 and so on till the data last. Through this method an investor can calculate the rolling return for the period of three years.

Rolling returns can help investors identify an investment's performance trends over time and evaluate its long-term potential. Additionally, rolling returns can highlight periods of underperformance or outperformance that may not be apparent when looking solely at annual returns.

Trailing returns 

Trailing returns are another measure of investment performance that looks at the returns of an investment over a particular period leading up to the present day. Trailing returns are commonly used by investors and financial analysts.

Trailing returns are calculated by measuring the returns of an investment over a fixed period ending on a particular date, such as the end of a month or quarter. For example, if an investor wants to evaluate the three-year trailing returns of a mutual fund as of 31 March 2022, then  they would look at the returns of the fund from 31 March 2019.

However, it's important to note that trailing returns reflect past performance. They do not guarantee future returns or take into account changes in market conditions or an investment's management. Therefore, investors should use trailing returns as just one factor when evaluating an investment's potential and also consider other factors such as risk, fees, and diversification.

Benefits and limitations of using annual, rolling, and trailing returns 

Now let's compare the benefits and limitations of these three types of returns:

Conclusion 

To evaluate investment performance, investors should consider using annual, rolling, and trailing returns. Each return type provides unique insights, with annual returns providing a snapshot of performance over a year, rolling returns offering a comprehensive view over multiple periods, and trailing returns providing a wider picture of performance by focusing on the average annual return.