Generally, people invest in mutual funds for a multiplicity of reasons, from building a corpus to making a profit over a relatively short amount of time. Depending on the risk capacity and investment horizon, there are plenty of schemes available for the investor. For an investor planning to take the first step or someone who already has invested money in mutual funds, understanding how mutual fund returns are calculated is quite informative. Let us take a look at the methodologies involved in calculating returns whether it’s a SIP (Systematic Investment Plan) or a lump sum amount.
Absolute returns
Absolute return considers only the initial and final NAV of a particular scheme. It is the increase or decrease in one’s investment without taking into account the time for which the investment was held. For example, if your initial investment was Rs 5 lakhs in 2012 and the current market value (in the year 2017) is Rs. 10 lakhs, the absolute return would be calculated as
(1000000-500000)/500000 = 100%
On the face of it, earning 100% returns is spectacular. However, without considering the time taken for appreciation, absolute returns do not portray the complete picture. Absolute returns are used if the investment period is less than a year.
For periods greater than a year, one would use annualised returns. Take any factsheet or fund tracker and expect to find a statement “Returns over 1 year are annualised” mentioned on the side.
Annualised returns
To calculate returns over a year, using annualised returns gives the investor a clear picture as to how their investment has performed over the time period. Compounded Annual Growth Rate (CAGR) is used to measure annualised returns. However, it shows how the investment would have grown at a steady or smoothened rate over a particular time period, which is not always the case.
CAGR is calculated as [(Current or Final value/ Initial Value)^(1/No. of years)]-1
Taking the above example itself, of Rs 5 lakhs investment in 2012 and the current market value (in the year 2017) of Rs 10 lakhs
CAGR = [(1000000/500000)^(⅕)]-1
= 14.87%
Therefore, for the same investment which gave an absolute return of 100%, the mean return over the five-year period is 14.87%.
While the above method is convenient for lump sum investors, people who have invested periodically or via SIPs can calculate CAGR using the XIRR (calculating the internal rate of return) function in Microsoft Excel.
All the investor requires is to enter the investment amount, the date of investment and the investment value as of the date of redemption. For example, assuming one had invested in a scheme of a Mutual Fund through SIP route for five years ago.
Illustration:
Their current investment status would be as follows:
Investment Period Mar 01, 2012 to Mar 01, 2017
No of Investments 61
Total Amount Invested 305,000.00
Total Units Purchased 868.88
Latest NAV 600.66000 (as on Mar 10, 2017)
Using the XIRR function under Formulas in MS Excel, the CAGR arrived at is 22.29%.
Step 1: Enter the date of investment in column A
Step 2: Enter the SIP amount in column B
Step 3: Enter the redemption amount in column B and the date of redemption in column A
Step 4: In any cell enter the following =XIRR(B2:B63,A2:A63). Make sure the final redemption amount is entered as a negative value in the spreadsheet.
Starting out an investment is just the beginning. Staying invested and making the right choices is what matters in the end. While many investors fret over the performance on a daily basis, for an average investor such a task will be tedious at best. Nor should an investor start an investment and forget about it. The right mix would be to keep a check on the portfolio on a routine basis.
Disclaimer: Mutual Fund investments are subject to market risks, read all scheme related documents carefully
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