How are mutual fund returns calculated?
Importance of understanding mutual fund returns
“XYZ Mutual Fund Scheme has delivered 25% returns”. We usually come across such statements in big, bold letters in print media or across the internet. In this article we will understand how these mutual fund returns are calculated, whether for lumpsum investments or SIP investments.
What is not mentioned in big, bold letters is whether these returns absolute returns or annualised returns. We wonder whether these returns are for a lumpsum investment or SIP investments. We also commonly come across terms like CAGR, XIRR, etc. We will also demystify terms like CAGR, XIRR. After reading this article, the next time you come across a headline related to mutual fund returns, you will exactly know what it means.
Mutual fund returns: Dividend and capital gains
We can earn returns from mutual funds in the following two ways:
- Dividend: The fund manager invests the investors’ money in the mutual fund as per the scheme objective in various financial products like equity shares, debt securities, or a mix of both, etc. For a mutual fund scheme with a dividend option, the fund manager will book profits from time to time when the expected profits are realised or as per the scheme mandate. The profit is then shared with the scheme unitholders in the form of a dividend. This is favourable for people who invest with the objective of getting regular returns on their investments.
- Capital gains: For long-term goals like accumulating a corpus for a child’s higher education or marriage, most mutual fund investors opt for the growth option rather than the dividend option. In such cases, the returns are measured in the form of capital gains. In the case of mutual funds, an investor’s capital gain per unit is the difference between the Net Asset Value (NAV) at the time of sale and purchase. The overall capital gain is the capital gain per unit multiplied by the number of mutual fund scheme units held by the investor.
Calculating mutual fund returns
Mutual fund returns can be calculated in different ways depending on the mode of investment (lumpsum or SIP) and the investment time duration (less than one year or more than one year). The below table summarizes how mutual fund returns are calculated depending on the mode of investment and time duration.
|Mode of investment and investment time duration||Mutual fund returns|
|Lumpsum for less than 1 year||Absolute returns|
|Lumpsum investment for more than a year||Annualised returns|
|SIP investment for more than a year||XIRR|
While you can always use a mutual fund calculator provided on many websites to calculate returns, you should know how the returns are calculated. Let us understand how mutual fund returns are calculated in each of the above scenarios.
- Absolute returns
For a lumpsum investment in a mutual scheme, if your investment time duration is less than 1 year, then you should calculate the absolute returns to analyse how your investment has fared. The formula for this is as follows:
Let us understand this with an example. An investor invested a lumpsum amount of Rs. 50,000 in a mutual fund scheme. After 6 months, the value of her investment is Rs. 55,000 at the time of redemption.
The investor made a profit of Rs. 5,000 on this investment.
We can calculate the absolute return as follows: (5,000 / 50,000) x 100
We get an absolute return of 10%
Absolute returns give you point-to-point returns. It calculates the difference in percentage between the money at the time of sale and at the time of purchase. Hence, this is useful for the calculation of mutual fund returns when the investment time horizon is less than one year.
- Annualised returns
When your mutual fund investment time horizon is more than one year, then calculating your returns using absolute returns will not give you the true picture. For a lumpsum investment in a mutual scheme with an investment time duration of more than 1 year, you should calculate the annualised returns or compounded annual growth rate (CAGR) to analyse how your investment has fared. You can calculate the CAGR using the RRI Function in an Excel sheet.
The RRI function requires you to input 3 parameters:
- Nper: This is the duration of investment in years
- Pv: The amount that you invested
- Fv: The current value of the investment at the time of redemption
Let us understand this with the help of an example. An investor invested Rs. 50,000 lumpsum in a mutual fund scheme. The value of the investment at the end of 3 years is Rs. 75,000. Let us see how the CAGR will be calculated using the RRI Function in Excel.
As can be seen in the above image, the CAGR in this case, will be 14.47%.
The annualised or CAGR tells you by how much compounded percentage your money has grown each year for the number of years the money was invested. Even though CAGR will give you a fixed number (for example, 14.47% in our example), the growth rate need not necessarily be uniform every year. There can be years when there is negative growth and there will be years when the growth is very high. Annualised returns or CAGR give you a steady compounded annual growth rate.
- XIRR (Extended Internal Rate of Return) returns for SIPs
We have seen in the above section how to calculate CAGR for a lumpsum investment with a time horizon of one year. While CAGR is useful for lumpsum investments, what if someone is making periodic investments, for example, a monthly systematic investment plan (SIP). These days, most mutual fund investors take the SIP route for investments. For a SIP investment in a mutual scheme, if your investment time duration is more than 1 year, then you should calculate the XIRR (Extended Internal Rate of Return) to analyse how your investment has fared. The XIRR name or full form may look a little scary. But, before you jump to a readymade SIP calculator, let us tell you it is not that difficult to calculate XIRR. Let us show you how.
You can calculate the XIRR using the XIRR Function in an Excel sheet. The XIRR function requires you to input 3 parameters:
- Values: This is the monthly investment over the number of months and the value of the investment as of the date of redemption
- Dates: These are the monthly dates over which the monthly investment has been made including the date of redemption
- Guess: You can leave this field blank
Let us understand this with the help of an example. An investor started a SIP of Rs. 2,000 per month on 1st Oct 2019 and continued investing for 16 months till 1st Jan 2021. He invested a total of Rs. 32,000 over these 16 months. He decides to redeem his investment on 1st Feb 2021. The value of the investment on 1st Feb 2021 is Rs. 38,000. Let us see how the XIRR will be calculated using the XIRR Function in Excel.
The XIRR in this case will be 26.54%.
Please note that the SIP amounts are shown in minus because these are cash outflows from the investor’s pocket. The fund value of Rs. 38,000 is shown in positive as this will be cash inflow for the investor on redemption. If the above calculation seems complex, you can always use a mutual fund SIP calculator available on many websites or apps.
Presentation of mutual fund returns
Now that we understand how mutual fund returns are calculated. Let us see how this data is presented by AMCs with the help of a sample. The below image is for Motilal Oswal Large & Midcap Fund.
Check how the absolute returns for 1 year for lumpsum amount, CAGR returns since inception for lumpsum amount, and SIP returns have been presented.
You are now an informed mutual fund investor
You now understand how mutual fund returns are calculated when planning for your financial goals. You understand the difference between absolute returns, annualised returns, and XIRR. The next time someone tells you a certain mutual fund scheme has given 25% returns in the last 3 years, be sure to ask them whether these are absolute returns or annualised returns. Also, ask them whether these returns are for a lumpsum investment or a SIP investment? Always remember, an informed investor is an empowered investor!
Now that you understand how mutual fund returns are calculated, you can download the Glide Invest App and start investing to accomplish your financial goals.