How to calculate SIP returns?

When investing in funds through a Systematic Investment Plan (SIP), you regularly invest a set amount every month. This approach differs from lump sum investments, where a fixed amount is invested all at once. Calculating the returns on these investments involves using methods depending on the varying nature of the investments. In this blog, we will discuss three ways to compute Mutual Fund returns - Absolute Return, Compounded Annual Growth Rate (CAGR) and Extended Internal Rate of Return (XIRR).

Absolute Return

Absolute Return is a way to determine how much you have gained or lost over a period. It is commonly used to assess investment growth over a period of less than a year. The formula for calculating returns is:

Absolute Return = Final NAV – Initial NAV ÷ Initial NAV x 100
Where:

• Final NAV is the Net Asset Value (NAV) of the fund at the end of the investment period
• Initial NAV is the NAV of the fund at the beginning of the investment period.

Let's consider an example for better understanding: 

Initial Investment: ₹ 1,00,000

Final Value: ₹ 1,30,000

By applying the formula: Absolute Return = ((1,30,000 - 1,00,000) ÷ 1,00,000) x 100 = 30%.

Important points about Absolute Returns:

• Ease of Calculation

You only need to know the value of your investment and the initial amount invested.

• Short Term Measurement

It's suitable for short-term investments.

• Limitations

It doesn't account for the investment duration, which makes it challenging to compare the growth rate of investments. The return percentage could be misleading without specifying a time frame.

Compound Annual Growth Rate (CAGR)

CAGR addresses the limitations of returns by factoring in the investment duration. It calculates the growth rate of your investment, considering compounding effects over time.

Important points about CAGR:

• Performance

Reflects the average annual performance of your investment.

• Long Term Perspective

Suitable for long term investment strategies.

• Volatility Consideration

It averages outgrowth and overlooks periods of returns or high volatility.

• Ideal for Lump Sum Investments

While beneficial for lump sum investments, it may not be suitable for SIPs due to the calculation required for each instalment.

Extended Internal Rate of Return (XIRR)  

XIRR is recommended for assessing returns on SIP investments. When you invest through a SIP, you make multiple investments at different time intervals. XIRR considers the timing and amount of each investment to provide a more accurate measure of your overall return compared to other methods like CAGR. 

For example, if you invested ₹ 5,000 every month from January to June 2017 and the maturity amount on July 01, 2017 was ₹ 31,000, the XIRR would be approximately 11.92%. This can be assessed with the below formula:

To utilise XIRR in Excel:

1. Enter all your SIP investment amounts as negative values in one column
2. In the next column, input the corresponding dates for each SIP investment
3. In the last row, add the total value of your SIP investments on the redemption date as a positive value
4. In the cell where you want the XIRR result, type the formula: = XIRR (cashflow range, dates range)
5. Press ‘Enter’ to see the annualised XIRR rate of return for your SIP investments.

Important Points about XIRR

• Includes all Instalments

It factors in all SIP instalments made throughout the investment duration.

• Simplified Calculation

The Excel formula streamlines the calculation process.

• Accurate Assessment of SIP Returns

It offers a view of SIP returns by consolidating CAGRs from each instalment.

Comparison between different approaches

Here’s an overview of the comparison between all three approaches.

How to use SIP Calculators?

1. Choose the investment duration

Decide how long you want to invest.

2. Enter the expected Rate of Return

Provide an estimate of the return rate you anticipate.

3. Calculate

Click on the ‘Calculate’ button to check your projected returns.

Utilising SIP calculators can assist in comparing Mutual Funds and selecting the one that suits your financial objectives best.

Conclusion

While calculating SIP returns may appear complex, understanding the methods can simplify the process. Absolute Return, CAGR, and XIRR each have their uses and advantages. Absolute Return is suitable for short-term investments, CAGR works well for long-term lump-sum investments and XIRR is particularly useful for SIPs.

Online SIP calculators further streamline this process by providing a user-friendly method to accurately estimate your returns. Ultimately, making investment decisions requires an understanding of how returns are computed and using it to your advantage to achieve your financial goals.

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