If you are an investor in mutual funds, you might have come across terms such as CAGR, XIRR and Absolute Returns. But do you know what they mean and how they differ from each other? In this blog post, we will explain these terms in detail and provide examples to help you understand the nuances of mutual fund returns.
Absolute returns refer to the total percentage increase or decrease in the value of an investment over a certain period of time. It is the simplest way to calculate returns and is often used by investors to compare the performance of different funds. For example, if you invest Rs. 10,000 in a mutual fund and it grows to Rs. 12,000 after one year, your absolute return would be 20%.
Compound Annual Growth Rate (CAGR)
CAGR is the average rate at which an investment grows per year over a certain period of time. It takes into account the effect of compounding and is a more accurate measure of returns than absolute returns. CAGR is calculated using the following formula:
CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) – 1
For example, if you invest Rs. 10,000 in a mutual fund and it grows to Rs. 12,000 after one year and Rs. 14,000 after two years, the CAGR over the two-year period would be:
CAGR = (14,000 / 10,000)^(1/2) – 1 = 0.19 or 19%
Internal Rate of Return (XIRR)
XIRR is a more advanced measure of returns that takes into account the timing and amount of cash flows. It is particularly useful for investments that involve periodic contributions or withdrawals. XIRR is calculated using the following formula:
XIRR = (Ending Value / Beginning Value)^(1 / Number of Years) – 1
For example, if you invest Rs. 10,000 in a mutual fund and make a monthly contribution of Rs. 1,000 for one year, and the value of your investment at the end of the year is Rs. 25,000, the XIRR over the one-year period would be:
XIRR = 0.30 or 30%
The following table provides a comparison of the three measures of returns using the above example:
|Type of Return||Value|
As you can see, the three measures of returns provide different insights into the performance of a mutual fund. Absolute returns are the simplest way to calculate returns, but they do not take into account the effect of compounding or the timing of cash flows. CAGR is a more accurate measure of returns, but it assumes that the investment grows at a constant rate over the entire period. XIRR is the most advanced measure of returns, as it takes into account the timing and amount of cash flows, but it requires more complex calculations.
In conclusion, understanding the different measures of returns can help you make more informed investment decisions. It is important to consider all three measures of returns when evaluating the performance of a mutual fund and to choose the one that best suits your investment goals and risk tolerance. At Wealthmunshi, our expert team of financial advisors can help you navigate the world of mutual fund investing and choose the right funds for your portfolio. Contact us today to learn more!