Mutual Fund Returns
When you are looking to check how well your mutual fund investment is doing, you may check the returns. But did you ever get curious enough to wonder what those terms like Absolute Return, CAGR, or XIRR mean?
Each of these words is telling you something different about investment performance. What are they held for? Well, if you want to make better decisions in terms of comparing fund options and calculating your real profit, this becomes important.
In this blog, we shall make simple such terms and show how return calculation works and finally guide you on which metric would suit your condition, whether you are an SIP investor, a lump-sum investor, or a comparison shopper for mutual funds.
Why Mutual Fund Returns Matters
Investing is not just about putting your money somewhere and hoping it grows. It’s about tracking how well your money is growing over time. That’s where the return calculation methods come in.
Different return formulas give you different perspectives:
- Absolute Return tells you the overall gain or loss
- CAGR: Compounded Annual Growth Rate: Annualized growth,
- XIRR-extended internal rate of return: Irregular cash flows.
Let’s break each of them down.
What is Absolute Return?
The most elementary measure that could measure how much your investment has grown in percentage terms.
Formula:
Absolute Return (%) = { (Final Value – Initial Value) / Initial Value } × 100
When to Use:
- Ideal for short-term investments. (under one year)
- One-time investments (lump sum)
Example: Assume you’ve invested ₹1 lakh in a mutual fund, and after 6 months, it reaches ₹1.2 lakh.
Absolute Return = { (1.2 lakhs -1 lakh) / 1 lakh } x 100 = 20 percent
That means your investment has grown by 20 percent within the span of 6 months. But it doesn’t tell you how that translates to an annual rate. This is where CAGR comes in.
What is CAGR (Compounded Annual Growth Rate)?
CAGR tells you how fast your investment has grown on average every year, assuming the gains were compounded through time.
Formula:
CAGR (%) = [(Final Value/ Initial Value) ^ (1 / n)] – 1 × 100
Where n = number of years
When to Use:
- Long-term lump sum investments (1+ year)
- To be able to compare the mutual funds’ performance across a period without any variations.
Example: Your ₹1 lakh investment becomes ₹1.8 lakh in 3 years.
CAGR = [(1.8 / 1) ^ (1/3)] – 1 = 0.223 or 22.3%
This means that your fund grew by an average of 22.3% a year over those years.
Key Benefit: CAGR smoothens out the ups and downs, showing a clear average growth rate over time.
What Is XIRR (Extended Internal Rate of Return)?
XIRR is a very complex return calculation, and this is to be adopted for multiple cash flows (investments or withdrawals) at different times. This is mostly done for SIPs and other irregular transactions.
Formula:
There is no simple formula like CAGR, but XIRR can be calculated by Excel or mutual funds platforms. It considers each cash flow’s timing and amount.
When to Use:
- SIPs (Systematic Investment Plans)
- Lump sum + additional purchases or redemptions
- Any investment with irregular cash flows
Example: You deposit ₹5000 monthly for 2 years and then have your total value at the end up to a sum of ₹1.4 lakhs.
According to Excel’s XIRR function or a SIP calculator, the return is 13.2%, which is the reality of the actual return that you earned, taking into account each installment.
XIRR is a money-weighted return- it holds true when and how much you invest.
Time-Weighted Return vs. Money-Weighted Return
Let’s demystify this recurrent confusion.
- The Time-Weighted Return
- Ignores the timing of cash flows
- Is only concerned about fund performance
- The Money-Weighted Return
- Considers both the timing and amount of investment
- Represents the investor’s experience more accurately
Example: Two investors in the same mutual fund- one invests ₹1 lakh and the other ₹10,000 every month. Even if the fund performs the same, their returns will differ due to differing investment occasions/or modes. Thus, XIRR distinguishes these outliers.
Case Scenario
In 2020, Meena invested ₹2 lakh as a lump sum. In 2024, the fund value rises to ₹2.8 lakh.
- Absolute Returns=40%.
- Time=4 years.
- CAGR= [(2.8 / 2) ^ (1/4)] – 1 = 8.78%
She also holds another fund wherein she invested ₹5,000 per month through an SIP during the same period, i.e. 48 months; the fund’s ending value was ₹2.75 lakh.
She used Excel to calculate the SIP’s XIRR, which came to 13.5%: XIRR is higher than the CAGR of the lump sum investment.
Hence, in a rising market, SIPs can provide better returns for investors even if the fund has performed similarly.
Conclusion
The metrics used when describing investments that would help to measure and categorize them are Absolute Returns, CAGR, and XIRR. These can give perspectives depending on the investment modes and investment durations.
Absolute Returns give a one-time view of the gains in a particular period. CAGR (Compound Annual Growth Rate) describes consistent returns that an investor would have earned over the years, making it best for long-term investments. XIRR will do just fine in any real-life situation that involves many transactions at different points.
Knowing these metrics in and out would be very helpful in their understanding and assessment of investment performance. It aids in the understanding and interpretation of returns earned during the past periods as it also helps build a fund of smarter investments for the future.
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Disclaimer – This article is for educational purposes only and does not intend to substitute expert guidance. Mutual fund investments are subject to market risks. Please read the scheme-related document carefully before investing.
