HOW TO CALCULATE MF RETURNS

In today’s scenario, many investors have started to invest or have been investing in mutual funds for a while now. But just investing the amount is not sufficient, an investor must understand the importance of calculating the returns on their investment in mutual funds so as to compare between different investment alternatives or funds, and ascertain which option is best to go forward with to meet their financial goals. After reading this article, the investors will be able to understand and calculate the returns on their mutual fund investments. Let’s get started.

CALCULATION OF ABSOLUTE RETURNS

This is often used to calculate the simple returns on initial investments usually when the holding period of investment is less than a year. However, it can also be calculated for holdings longer than 1 year. The result will indicate the absolute return earned on investment for the specific time period from the date of investment.

This method calculates the percentage increase or decrease in the value of NAV over a specific time frame. Here is the formula to calculate the same:

Absolute Returns = (Current NAV- Initial NAV)*100/Initial NAV

Illustration:

If the initial NAV is 100 and the current NAV is 125,

Then the absolute returns calculated by the above formula will be 25%

CALCULATION OF CAGR (Compounded Annual Growth Rate)

CAGR tells us the growth rate at which an investment has grown on an annual basis. It is an ideal way to calculate past or futuristic returns of how the investment would have grown had it generated constant steady returns when the time frame is a year or over a year. In simpler words, CAGR can be explained as annualized returns with the compounding effect.

For instance, imagine, you purchased gold worth Rs. 20,000 in 2010 and it is worth Rs. 60,000 in 2020, here CAGR will be the rate at which your investment in gold grew every year.

One should note that this number is not absolute, rather it is an assumption. If the gold you bought grows at 11.6% from 2010 to 2020, it does not indicate that it will grow at this rate every year. The on-ground actual growth can be different, but this surely gives us an idea of how much growth potential our investment has on an annual basis.

The formula for the calculation is :

[(Ending Value/Initial Value)^(1/No. of years) - 1] X 100

Illustration:

Initial NAV is 100, After two years, NAV is 150.

Then CAGR will be : [(150/100)^(½)-1] X 100

= 22.47%

CAGR IN EXCEL

CAGR can also be calculated in excel very conveniently. The formula used in Excel is :

CAGR = (Ending Value/Initial Value)^(1/n)-1

The Power function can also be used while calculating CAGR. Here is the formula for the same:

=POWER(Ending Value/InitialValue,1/n)-1

The Rate function can also be used while calculating CAGR. Here is the formula for the same:

=RATE(Nper, Pmt, Pv, [Fv], [Type], [Guess])

Where RATE is the function initiator, Nper is the total number of payments done,

Pmt is the value of the payment made in each interval

Fv is optional and indicates the future value of the payment

Type indicates when the payments are due

Pv is the present value of the payments

And, Guess is optional where we can put a guess on the rate.

CAGR gives investors a better picture of the returns but it also has some limitations. It considers investments made during a particular period. Hence, CAGR is more ideal for lumpsum investments. But in today’s time, the SIP route is very popular among investors. And calculating CAGR with respect to SIP will not give a true picture. Let’s take an example to understand.

Suppose an investor starts a SIP of Rs. 5,000 in a scheme. The start date is 1st Jan 2021 and the end date of SIP is 1st December 2021. The investment over the period will be Rs. 60,000. And the end value of the fund is Rs. 65,000.
CAGR here will be: (65,000/60,000)^(1/1)-1 = 8.3%

Looking at this return, the investor may decide to sell the fund. As Rs. 5,000 gain has been made in 12 months. That’s Rs. 416.67 per month. But, this is wrong. Because of the entire Rs. 60,000 was not invested on 1st Jan. Let’s discuss how we can ascertain the true picture of SIP returns.

CALCULATION OF RETURNS OF SIP

For this purpose, a very useful excel function XIRR can be used to calculate the Internal Rate of Returns for an array of cash flows occurring at regular intervals. One needs monthly SIP amount, dates of investment made, date of redemption, and redemption amount for the calculation of the same.

Illustration:

An investor invests Rs. 2,000 every month for the last one year and the value of his investment became Rs 26,000 because of the increase in NAV.
If we use this data and put it in the formula of XIRR in excel or spreadsheet, we will get an answer of 15.65% which is nothing but the IRR.

Also, the following formula can also be used to calculate the future value/maturity value of SIP

FV = P[(1+i)^n -1]/i*(1+i)

where P is the amount invested through SIP

FV is the future value, n is the number of months, i is compounded rate of return, If the returns are compounded for every investment installment made, Monthly SIP will be compounded by taking i/12, And for daily SIP, we will take i/365.

CALCULATION OF ROLLING RETURNS

These returns are the average annualized returns of daily/weekly/monthly returns of the investor till the last duration of the mutual fund. It displays the relative and absolute performance over regular intervals of time. They can be termed as annualized average returns for a period, ending with the listed year.

For instance, let us take a 5-year rolling series starting 1 April 2004 for 15 years. Thus, the returns would be calculated from 1 April 2004 to 31 March 2009; 1 April 2005 to 31 March 2010,1 April 2006 to 31 March 2011 and so on. Several such blocks of 3,5 or 10 years of time frame are taken in rolling returns to observe how the funds have performed in different intervals over the given time horizon, which gives the accurate performance of the fund and makes it more indicative.

Analyzing rolling returns could demonstrate annual performance not simply starting from 1 April and ending 31st March but also beginning 1st May and ending 30th April of the next year, then 1st June through 31st May of the next year, and so on. A 3,5,10-year rolling return like this can be assessed to highlight a fund’s best and worst periods in this form.

FAQs

1. What is the method of calculating returns on mutual funds?

Some of the methods for calculating the returns on mutual fund investments are absolute, CAGR, IRR, or Rolling returns method according to the situation.

2. What are the methods to calculate return on SIP in mutual funds?

IRR or Calculation of Future Value can be considered for calculation returns on SIP in Mutual Funds.

3. Why is it important to know how to calculate return on mutual funds?

An investor must understand the importance of calculating the returns of investment in mutual funds so as to compare between different investment alternatives or funds and ascertain which option is best to go forward with to meet the financial goals.

4. What is a mutual fund's returns calculator?

A mutual fund return calculator helps the investor to input data and get the answer of how much corpus or returns they will be able to build over the specified time frame. ZFunds is coming with its calculator soon. Stay tuned for the same.