With a gamut of options for different risk appetites, multiple investing modes like SIP (Systematic Investment Plan) and lump sum investments, as well as inflation-beating returns, mutual funds are rightly one of the most popular investment instruments in India.
One can invest in a mutual fund scheme for varied goals and needs, both long-term and short-term. Different income groups can also use mutual funds as they allow investments as little as Rs 500. However, before you choose a mutual fund, you must know how its returns are calculated. Not only will this help you pick the right product, it will also help you track your investments along the way.
SIP calculators offer you simplified solutions in a matter of minutes. They are easy to use and can come up with precise estimates of your SIP returns. Here are five things to know about how your SIP returns are calculated:
- Compound Annual Growth Rate (CAGR)
There are three ways to calculate the returns from a mutual fund. The first is known as the compound annual growth rate (CAGR) method. As the name suggests, CAGR is the compounded growth rate of your investment over a period of time. It can be used to calculate the historical returns of different mutual funds.
CAGR is calculated based on three things:
- The beginning value of your investment
- The ending value of your investment
- The tenure of your investment
Formula to calculate CAGR: [(Ending value/ Beginning value) x (1/Tenure)] – 1
- Extended Internal Rate of Return (XIRR)
XIRR is a more accurate method to calculate the returns from a SIP. When you invest through SIPs, you can have multiple investments of different values for different durations. XIRR calculates the CAGR of each installment and adds them up to give you the overall compounded growth rate of the investment.
You can calculate XIRR in Excel by using the function = XIRR (value, dates, guess)
- Absolute Returns
The third method to calculate the returns from mutual funds is the absolute returns method. This method shows you the point-to-point growth of your investment. You can use this to check the total profit or loss from a mutual fund scheme.
Formula to calculate absolute returns: (Final value – Initial value) / Initial value x 100.
Choosing the Ideal Method for Calculation
All of these methods have their pros and cons. Absolute returns are very easy to calculate. However, since the formula does not use the investment tenure, you cannot ascertain the exact growth of your investment over time.
XIRR may be the most accurate when calculating the returns from a SIP. It is also easy to use in Excel. CAGR is ideal for calculating the annual average returns of a mutual fund. However, it may be better suited for lump sum investments and is inaccurate when calculating SIP returns.
Understanding these different methods to calculate the SIP returns can help you plan your mutual fund investments better. Now that you are familiar with the basics, why not install the Tata Capital Moneyfy App and consolidate your investment journey?