How To Calculate Mutual Fund Returns?

What are Mutual Fund Returns?

Mutual funds pool resources from various investors and invest in different equity and debt securities. Returns generated from investment in various financial securities by the mutual fund houses are distributed amongst its investors in proportion to their respective investment amount.

While making any financial decision, an individual should know his/her financial goals, time horizon to fulfill those goals and returns expected from different investment instruments. Mutual Funds also comes under the purview of these investment  instruments, wherein investors should evaluate the expected returns from different schemes and then choose the one in line with their financial plan.

Absolute Returns

Absolute Return of a mutual fund refers to the amount of total change in the value of a mutual fund investment at the time of redemption. For example, Mr. A invests Rs. 1 lakh in a mutual fund scheme in January 2016. The value of the mutual fund invests stands at Rs. 1.3 lakh in January, 2019. Thus, the absolute return earned by Mr. A on his investment over a period of 3 years can be calculated as follows:

Absolute Return = ( Final Investment Value – Initial Investment Amount) * 100 / Initial Investment Amount

Absolute Return on Mr. A’s investment over 3 years

= (130000 – 100000) * 100 / 100000

= 30%

An absolute return is always expressed in the form of a percentage (%).

Annualised Returns

Annualised Return refers to the return earned on a mutual fund investment on a yearly basis. It assumes that the investment has grown at a constant rate. Let’s better understand annualised return by calculating the annualised return of the above quoted example.

Annualised Return = (Final Investment Value  ÷ Initial Investment Amount)^ (1/number of years) – 1

Annualised Return on Mr. A’s investment = [(130000/100000)^(1/3) – 1]    = 9.04%

Thus, Mr. A’s investment grew at an annualised rate of 9.04% every year for 3 years.

How Does a Mutual Fund Return Value Calculator Work?

One should make use of a mutual fund calculator to calculate the final return value on the basis of expected rate of return. Paisabazaar’s Mutual Fund Calculator is an easy to use tool for predicting returns on investment. 

An investor needs to put in the principal investment amount and the expected rate of return, to know the final maturity amount payable at maturity. Conversely, investors can also put in the expected maturity amount to predict the rate of returns on their investment.

What is Compounded Annual Growth Rate (CAGR)?

CAGR tells us about the growth of a particular investment over a specific time period. It takes into account the interest earned on principal investment as well as the interest earned on accrued interest.

It becomes important to use the CAGR for analysing investment returns as it incorporates the time value of money. Compared to absolute returns, CAGR presents a better picture of how good a particular investment scheme is. It averages down the volatile returns over the investment horizon.

However, when the investment stretches over a span of time with installments at irregular intervals, it becomes difficult to calculate CAGR. Instead, Extended Internal Rate of Return is used to predict returns on investment via SIP.

How to Calculate Returns on SIP of Mutual Funds?

Systematic Investment Plan (SIP) involves regular investment of small amounts of money in mutual fund scheme at predefined interval. If one pays monthly installment, and redeems it on a particular day, returns for each SIP investment will vary as the holding period of each SIP varies.

When you invest via SIP, you essentially buy units of the mutual fund scheme based on its Net Asset Value on that particular day of the month. When you redeem your investment, you get the amount equivalent to the number of units you hold multiplied by the NAV of the mutual fund on the day of redemption.

To calculate mutual fund returns for SIP mode of investment, we use XIRR (Extended Rate of Return) to predict the overall rate of return on the invested amount.

XIRR refers to aggregation of multiple CAGRs on each SIP Investment. For this, it is best to use SIP calculator rather than individually checking CAGR for each investment you make via SIP.

It is also helpful when there are irregular cash flows via Systematic Investment Plan (SIP) and Systematic Withdrawal Plan (SWP). It incorporates the complexity of all the investments and withdrawals and gives a consolidated return value.

For instance, consider the following investment where an investor makes an investment of ₹ 2,000 at regular intervals for 5 months. The total principal amount comes out to be ₹10,000. however , at the end of 5 months, she gets an amount equal to ₹11,000.  

Extended Internal Rate of Return for the above investment = 45.27% per annum