How To Measure Mutual fund returns: XIRR, CAGR & Rolling Returns?

CAGR vs XIRR vs Absolute Returns?

As an investor putting your hard-earned money into the hands of mutual funds managers obviously requires some homework on your part too. You need to spend some time understanding the answers to these key questions

  • What is the legacy of the AMC(Fund house ), who will be the custodian of your money?
  • Who is the fund manager? Since how long s/he has been serving the industry, what kind of returns s/he has given to their investors
  • What is the expense ratio, entry load, or exit load?
  • What are the tax implications on your ROI?
  • What is the rating of the fund scheme from CRISIL, Morning star, and other rating agencies?

All this info can be referred by going to the fund house website, where they are mandated to publish the Fund Fact sheets for the public. Also, you can go to the Morning star web portal to do the research.

One key thing which everyone should also understand before investing in a mutual fund is to know how their return on investment is measured/calculated? Today in this article this will be our main objective. We will decode, how the AMCs calculate return on your invested money? and what you should know before even putting your first foot forward into mutual fund investing?

Measuring the ROI?

The mutual fund industry has formulated certain calculations & metrics regarding ROI, which is imperative for each investor to understand. This will make you well-informed investors and help you make a wise decision to select the best funds and fund houses.

Let me list down a few of the key metrics which we will cover in this learning journey

  1. Absolute Returns,
  2. CAGR
  3. XIRR
  4. Rolling Returns

Most investors are often not clear when it comes to measuring their mutual fund returns and generally end up measuring the same in absolute terms which is a very standard way and often does not give a clear picture.

These returns are the barometer to measure the mutual fund scheme’s performance and so it is very important that each one of us has a clear understanding of the same

So let me first clear a few of the basic concepts, in order to effectively understand the returns one should understand these modes of investments

  • LumpSum : Suppose you have a surplus of Rs 50000 and if you want to invest in one go then you can do so in the LumpSum mode
  • SIP(Systematic Investment Plan ): But if you want to invest that 50k in small fixed installments like Rs 1k or 2k etc every month, on a fixed monthly date in any designated fund, you can do it in the SIP mode which is also known as the systematic mode of investment. This mode is the most favorable and proven way to create wealth over the period of 5–10 years

Now that you have a basic understanding of the terms it's time to clarify that returns on these two modes need to be calculated differently and time is one of the key factors which one should always factor in to measure the performance of their investments.

How To Measure Returns For My LumpSum Investment?

When it comes to LumpSum the best way to measure the performance of your fund scheme is

  • Absolute Return If your investment is only for 1 or less than 1 year, absolute returns are what you should consider.
  • CAGR(Compounded Annual Growth Rate ) If you want to invest your surplus amount in Lumpsum mode and want to remain invested for more than 1 year, CAGR is the best metric to measure the ROI.

Absolute Returns In LumpSum case: By Example:

Just to remind you once again that while Absolute returns makes sense only for investment of <1 year. Also it is used both for SIP or Lumpsum mode of investment

For example :

Suppose you have invested Rs 5000 as LumpSum in Jan 2022 and till July 2022, the value of the fund has increased to Rs 7000. So how to calculate Absolute return

Absolute Return (in % terms )= (Ending Values(till date)/Starting Value(at the time of investment))-1

= ((7000/5000)–1)*100

= 40%, will be your absolute return for the investment made in less than 1 year.

CAGR Returns In LumpSum case: By Example:

CAGR is an abbreviation of Compound Annual Growth Rate that measures your investments’ average annual growth over a given period. CAGR is a useful tool as it precisely measures the growth (or decline) of your invested amount in LumpSum mode.

Remember CAGR is not useful for SIP

Let's understand CAGR calculation with an Example:

Suppose you have invested Rs 10000 as LumpSum in Jan 2018 and till Jan 2022, the value of the fund has increased to Rs 15000. So how to calculate the ROI using CAGR

The formula to calculate the CAGR is

(Ending Value/ Starting Value )^(1/n)-1,

Here n= is the time in years

= ((15,000/10,000)^(1/4))-1)*100

= 10.66%

This means your investment has grown at a rate of 10.66% year on year basis.

2. Measuring Returns Against My SIP Investments:

If you are investing in SIP mode and the time period is less than a year you should calculate the Absolute return in that case

Absolute Return (For SIP < 1 year)with Example:

Suppose you have invested Rs 10000 every month(SIP) for 9 months, so now you want to measure the ROI on the same. Since the tenure here is <1 year, so we will need to calculate Absolute returns

  • Monthly SIP Amount= 10,000
  • Tenure= 9 months
  • Total invested value= 10,000*9= Rs 90,000
  • Current value(when you are calculating the return) = 95,000

Absolute Return(in %)= ((Total invested value/Current value)-1)*100

= ((95000/90000)-1)*100

= 5.55 %, will be your Absolute returns in 9 months.

Can XIRR not be used to calculate returns for SIP investment of <1 year? Yes, one can do so, but it is not the best methodology when your tenure is not beyond 1 year, we will understand the same in our XIRR section.

XIRR For SIP(> 1 year):

XIRR is an abbreviation of Extended Internal Rate of Return.

XIRR is an extremely useful tool to calculate the returns on your investment made in SIP mode for multiple years.

Let’s understand XIRR by Example:

Assume you invest Rs.10,000/- on the 1st of every month in a mutual fund. You started the investment process on 1st Jan 2021, and the current value on the date 30th of June 2023 is Rs 3,50,000

So if you apply the XIRR formula result will be 12.41 %, Also if you look for the absolute returns here it will be 14.29 %(which is not a surprise).

See the excel file attached below:

Note!
XIRR calculations may intimidate you, so it is advisable that for XIRR Calculation, use XIRR Function in MS, excel.

As shown in the picture, the excel function to calculate XIRR requires two inputs –

  • The series of cash outflows and the current value of the investment
  • The respective dates of cash flow and the date of the current value

Then click ok to get the XIRR result.

You can also use Google Spreadsheet, Go to the Function section, and select the Financial menu option, there you can find the XIRR formula.

Is There Any Relation between XIRR & CAGR? Are They the Same?

Do you know XIRR is nothing but the evolved version of CAGR itself? Both metrics serve the common purpose of calculating returns effectively for multiple years, the only thing that differentiates them is that when it comes to SIP mode XIRR is quite handy.

What about Lumpsum, Will returns calculated by CAGR and XIRR give the same results?

Let’s understand the same by taking an example. Let’s me revisit the same example that we employed in the CAGR calculation earlier.

Suppose you have invested Rs 10000 as LumpSum in Jan 2018 and till Jan 2022, the value of the fund has increased to Rs 15000. So how to calculate the ROI using CAGR

The formula to calculate the CAGR is

  • (Ending Value/ Starting Value )^(1/n)-1,
  • Here n= is the time in years
  • So if we key in the inputs
  • CAGR(in %)= ((15,000/10,000)^(1/4))-1)*100= 10.66%

Now Let’s Take The Same Assumption & Calculate XIRR:

Use the same strategy as discussed above in case of XIRR (SIP)section and input

  • Starting LumpSum amount = Rs 10000
  • Starting date: 1st Jan 2018
  • End value on 1st Jan 2022 = Rs 15000

You will find that XIRR in the case of LumpSum investment is 10.66% , which is also the return in case of CAGR.

Now that you have fare bit of understanding about

  • Absolute Returns
  • CAGR
  • XIRR

It’s time to go one more step ahead and learn about Rolling Returns

What is Rolling Returns?

Before we discuss rolling returns, we should also know about point-2-point returns. The returns we just calculated in the case of the above examples leveraging CAGR, and XIRR all required two fixed days, so whatever value we calculated was derived and will be valid for these dates itself. This is known as Point-2-Point returns.

What if you want to measure the returns on any other dates instead of these fixed dates, then Rolling Returns will be handy.

Rolling Returns:

Rolling returns, also known as “rolling period returns” are annualized average returns for a period, ending with the listed year.

Rolling Returns helps to measure the returns at different points in time

It is used to track the fund's growth(performance ) on a relative and absolute basis at regular intervals. Intervals may vary between, 2, 3, 5, 10 years, etc. This kind of return covers both upside and downside market trends and is often preferred by investors to measure their portfolio performance over a period of time.

So as an investor if you want to compare and analyse two mutual funds over a more extended period of time, rolling returns will help you get more peculiar insight into the market condition and fund’s performance.

Let’s try to understand the same by example :

Suppose Mr XYZ bought a mutual fund scheme worth Rs 200, 1 year ago and today redeemed it for Rs 210, so trailing returns will look like 10 %, but what if the value of the same fund falls back to Rs 208, obviously the fund's performance in this 1-year time frame will give a precise picture as this volatility and the price change needs to be factored in. Rolling returns will give a more precise analysis in this case.

It will consider funds returns over multiple time intervals like 1st Jan -1st Feb, 2nd Jan — 2nd Feb, 3rd Jan — 3rd Feb, etc. And come up with the average of these varying returns to give you a more accurate result.

Why Rolling Returns?

  • It is an effective metric to measure the performance of mutual funds.
  • It is more precise and informative to sense the fund's return
  • It is very insightful for investors who want to research before committing their funds
  • If you are a SIP investor this one can be really helpful metrics
  • Rolling returns thus give you a measure of consistent fund performance between any two dates. One way to check consistency is to know if the average of rolling returns for the mutual fund is higher than its benchmarks.

The higher the better — it means the fund has beaten the benchmark for more rolling intervals.

Maths of rolling returns could be quite complex to cover in this article, but if you still want to get your hands dirty here is some of the links where you can do so

What’s Next?

In our Personal Finance education series, next

  • We will cover the concept of Funds & NAV: Net Asset Values and How To Calculate The same
  • Learn how to read and understand Mutual Fund Fact Sheets?

Would like to close this part with this

Food for Thought:

When your idea is to generate wealth for the future, you can’t do it overnight, there is no shortcut to it, the most proven way is to start early, start small, stay consistent, and go long.

The mutual fund has all the ingredients to make you attain your financial wellness but it requires you to refrain from timing the market and get some fundamental knowledge about how it works. So get educated and be patient with it.

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@pramodAIML

@pramodAIML

Passionate Blogger & Tech Entrepreneur | Founder of FinTech Startup | Write about AIML, DevOps, Product Mgmt & Crypto