If you get confused listening about Mutual fund returns, then, you are not alone. It is a little difficult to understand mutual funds returns. Most people get intimidated listening to heavy words like CAGR, Absolute Reuters, XIRR, etc. But, this will not happen anymore.
In this video, we will tell you about different types of mutual funds returns and will discuss how they are different from each other, and...
There is one important thing. All mutual fund returns - whether it is CAGR or XIRR, tell about the historical aspects meaning older returns of the fund. Through them, you get to know about the performance of the fund during the chosen period. They are not predictions for future returns.
👉 CAGR - Compounded Annual Growth Rate.
CAGR is the return type that is most commonly used while discussing the performance of any fund.CAGR tells you about the compounded growth rate of your mutual fund investments.
CAGR can help you understand this. In order to calculate the Compounded Annual Growth Rate (CAGR) we need - Initial Investment Value (IV), Final Investment Value (FV), and period of investment (n).
The formula to calculate CAGR is:
CAGR = (Final Investment Value/Initial Investment Value)^1/n – 1
In this manner, you can check the CAGR of different funds over 3, 7, and 10 years of different time frames.
So, next time when you hear or know about the CAGR of a fund, then be understood that this is the average annual returns that a fund has generated over a time period.
First, CAGR does not give you a clear picture of volatility. Seeing this, you may feel that your investment has had or had a linear growth. This means that it has grown at a fixed rate every year, however, the reality is that the value of the investment may differ every year.
Second, though CAGR is the most used and popular way to calculate mutual fund returns, it has a limitation, that it doesn’t take into account the periodic investments. In the example given above, if the investment was made on different dates in the year, then, CAGR would not have been able to give a correct picture of the returns. It is ideal for calculating returns from a point-to-point basis. Therefore, CAGR is a correct method to calculate returns for a one-time lump sum investment, but not to calculate the SIP returns.
So, the question arises that if CAGR is not the correct method to measure the returns from SIP investment then what is?
👉 XIRR - Extended Internal Rate of Return
CAGR is fine for lump sum investments, but in places where there are different cash inflows and outflows, like SIPS, CAGR is not a good measure.
That is because every installment of a SIP is a new investment, therefore each amount is invested for different time durations. For example, in a 5-year SIP, your first installment will be invested for 5 years, the second installment for 4 years 11 months, and so on. For this reason, every amount gets compounded for different periods.
The Extended Internal Rate of Return (XIRR) takes this into account. In XIRR, CAGR is calculated for every installment and then the overall Compounded Annual Growth Rate is taken out after adding them all together.
You can calculate the XIRR in excel but we have made it much easier. You can see the SIP returns of every fund for any amount and duration on the scheme page of ETMONEY.
So, till now we have discussed the returns from mutual funds investments held for more than a year. Now, you must be getting the question: how to calculate the returns on investments for a year or less? The answer to it is Absolute returns.
👉 Absolute Returns
Absolute returns or Total returns means how much you have gained or lost in your investment.
Whenever you choose an equity fund, then do not judge the fund with its absolute or one-year returns, but evaluate it on the basis of CAGR or XIRR meaning more than a year (3/5/7/10 year’s returns).
👉 Bottom Line:
At the end of the day, we all invest in mutual funds to grow our money and earn better returns. So by knowing the intricacies related to mutual fund returns, you can pick the best funds for yourself. Once you’re invested, it also helps you gauge whether you got a good return for your money or not. You can use these returns to evaluate your mutual fund investments with other avenues like bank deposits, gold, and more.
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