Investing in mutual funds is popular with beginners and experienced investors. Whether you are a new or old investor and want to invest for a short-term or long-term goal, one of the key challenges while evaluating mutual fund performance is understanding their selection technique and comparing the returns. In this article, we will focus on the methods of measuring mutual fund returns (Rolling Returns Vs Trailing Returns), their differences, advantages, and disadvantages, and how they can be utilized by investors like you to assess the performance of mutual funds effectively.

There are two main methods of measuring mutual fund returns: trailing returns and rolling returns. While they both serve the same fundamental purpose – to evaluate the past performance of a mutual fund – they do so in different ways, and understanding these differences is crucial in making informed investment decisions.

What are Trailing Returns?

Trailing returns refer to the historical returns of a mutual fund over a specific time frame. This return is calculated based on a point-to-point fixed time frame, such as 1 year from today, 3 years from today, 5 years from today, or 10 years from today, and also known as point-to-point return.

The most common trailing returns used in mutual fund performance reports are:

• 1-Year Trailing Return: The return of a fund over the previous 12 months.
• 3-Year Trailing Return: The compounded annual return over the past 3 years.
• 5-Year Trailing Return: The compounded annual return over the past 5 years.
• 10-Year Trailing Return: The compounded annual return over the past 10 years.

Trailing returns are widely used by investors to quickly assess how a mutual fund has performed over the past. However, it may not give you the right picture of the fund performance, and we will look into it below with an example.

For example, If an investor looks at the trailing 1-year return of a mutual fund from today (26-Feb-2025), it will show the fund’s performance over the past year (26-Feb-2024 to 26-Feb-2025). Similarly, a 3-year trailing return shows the performance of the fund over the last three years (26-Feb-2022 to 26-Feb-2025), and a 5-year trailing return shows the performance of the fund over the last five years (26-Feb-2020 to 26-Feb-2025).

If you observe closely, you will find the trailing return missing out on the analysis of fund performance consistency and return depending upon when you calculate it. The return may look excellent in the bull market, whereas in the bear market, the return may look pathetic.

Advantages of Trailing Returns

1. Simplicity: Trailing returns are easy to understand and calculate, making them an attractive option for beginner and experienced investors.
2. Widely Used Metric: Since trailing returns are widely reported by mutual fund companies, brokers, and online platforms, they offer a standardized measure for comparison across different funds.
3. Clear Snapshot: Trailing returns offer a clear snapshot of how the fund has performed over the chosen period, making it simple to evaluate its past success.

Disadvantages of Trailing Returns

1. Limited Time Frame: Trailing returns focus on a single time frame, which may not reflect the fund’s long-term performance trends. They do not account for the volatility of returns within that period.
2. One-Time Calculation: As trailing returns only reflect performance over a specific period, they do not represent a fund’s ability to perform consistently across different market conditions.
3. Impact of Market Cycles: The most significant disadvantage of the trailing return is that the market conditions during the specific trailing period can significantly impact the reported return. A fund might have performed exceptionally well during a bull market but poorly during a bear market.

Looking at the disadvantage of trailing returns, it seems inappropriate to consider trailing return methods for measuring mutual fund returns; this is where rolling returns come into the picture.

What are Rolling Returns?

Rolling returns, in contrast, evaluate its returns over consecutive overlapping periods. Instead of using fixed time intervals like trailing returns, rolling returns continuously “roll forward” by shifting the time frame by a specified period on a daily basis; this method generates multiple return values based on the same fund, allowing investors to understand the consistency of a fund’s performance over time.

For example, If an investor wants to calculate the rolling 1-year return for a mutual fund, they would calculate the return for each trading day within a chosen time frame. For a five-year period, considering 250 trading days in a year, the data will be considered for calculation 250*5=1,250 days, and an average of these returns will be separated as a 1-year rolling return.

The primary benefit of rolling returns is that it smooths out the performance and gives investors a clearer picture of how the fund performs in different market conditions over a prolonged period, hence eliminating any bias associated with returns observed at a particular point in time.

Advantages of Rolling Returns

1. Consistency: Rolling returns help identify whether the mutual fund has consistently outperformed over different time frames and market conditions.
2. Smoothens Volatility: Using overlapping periods, rolling returns smooth out short-term volatility and provide a more holistic view of the fund’s performance.
3. Provides More Data: Instead of looking at a single data point (like in trailing returns), rolling returns provide multiple data points over time, offering a more robust and detailed assessment.
4. Better Reflection of Long-Term Performance: Rolling returns give a better reflection of how the mutual fund performs over different market cycles, providing a more comprehensive analysis.

Disadvantages of Rolling Returns

1. Complexity: Rolling returns require more sophisticated calculations and can be more complex to analyze.
2. Data Overload /Limitation: Rolling returns generate multiple data points, which might overwhelm investors or make it harder to focus on any specific period for older funds, whereas, for newer funds, there might be insufficient data available to make rolling return calculation meaningful.

Key Differences: Trailing Returns vs Rolling Returns

1. Time Frame
   • 🔹Trailing Returns are calculated over fixed periods (1-year, 3-year, etc.) and show the fund’s return from the end of the specified period.
   • 🔹Rolling Returns use overlapping periods and generate multiple returns for a given time frame, such as calculating the 1-year return for 250 trading days within a larger time frame (e.g., rolling 1-year returns over 5 years). 
2. Number of Data Points
   • 🔹Trailing Returns offers one return number for each specific period.
   • 🔹Rolling Returns offer multiple return values within the same time frame, providing a deeper insight into how the fund performs in different market conditions.
3. Smoothing Effect
   • 🔹Trailing Returns may reflect the impact of short-term volatility or market cycles as they focus on a specific time frame.
   • 🔹Rolling Returns smooth out volatility by averaging performance over multiple overlapping periods, providing a more consistent long-term performance measure.
4. Usefulness
   • 🔹Trailing Returns are suitable for a quick snapshot of performance but may miss out on long-term trends and market cycles.
   • 🔹Rolling Returns provide a more nuanced view, helping investors understand whether a mutual fund consistently generates positive returns across different time frames and market cycles.
5. Data Accessibility
   • 🔹Trailing Returns are easier to find on most mutual fund reports, investment websites, and brokerage platforms.
   • 🔹Rolling Returns require more in-depth analysis and may not always be readily available, as they require calculating returns for multiple overlapping periods.

When Should You Use Trailing Returns vs Rolling Returns?

Use Trailing Returns When:

• ✔️You want a quick and easy overview of a mutual fund’s recent performance.
• ✔️You are comparing mutual funds for short-term performance, such as over the past 1 year or 3 years.
• ✔️You are not concerned with the consistency of returns and just want to see how the fund performed during a specific market cycle.

Use Rolling Returns When:

• ✔️You are focused on long-term investment strategies and want to assess the consistency and sustainability of a mutual fund’s performance.
• ✔️You compare funds across different market cycles to ensure that a fund consistently performs well, not just during specific bull or bear markets.
• ✔️You want a deeper, more detailed analysis of a mutual fund’s performance to gauge its long-term reliability and risk profile.

Rolling Returns Calculator

Bottom Line – Both Trailing & Rolling Returns Are Important

Both rolling returns and trailing returns offer valuable insights into mutual fund performance, but they do so in different ways. Trailing returns provide a snapshot of performance over a specific, fixed period, which is easy to calculate and useful for quick comparisons. On the other hand, rolling returns offer a more comprehensive and consistent measure of a fund’s performance over time, considering multiple overlapping periods and smoothing out volatility.

When making investment decisions, it’s important to consider both methods to gain a complete understanding of a mutual fund’s performance. While trailing returns can give you an idea of how a fund has performed recently, rolling returns can help you assess the fund’s consistency over the long term. By using both methods jointly, you, as an investor, can better align your investment choices with your risk tolerance and financial goals.