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# Calculating Mutual Fund Returns: Difference Between CAGR, XIRR And Absolute Returns

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The performance of a mutual fund is a key concern for investors. However, many may find it difficult to understand and assess their investment’s performance. There are several methods to assess a mutual fund scheme’s return. Three common ways are Compound Annual Growth Rate (CAGR), Extended Internal Rate of Return (XIRR) and absolute returns. Understanding these metrics can help investors better interpret their mutual fund returns and determine their progress towards their financial goals.

## Overview of calculation methods

To evaluate mutual fund returns, you can use different metrics. Each method provides unique insights into your investment performance. The three main methods are:

Absolute returnsCalculates the total percentage increase or decrease in your investment.

CAGR: Shows the annual growth rate of your investment over a specific period of more than a year, assuming that your gains are reinvested at the end of each year.

XIRR: Calculates the annualized return taking into account multiple cash flows at different times. This provides a more accurate return rate for investments that were made periodically at regular and irregular intervals. It accounts for any payouts in form of dividends, redemptions and also if there has been any additional investments.

By understanding these methods, you can get a clearer picture of how your mutual fund investments are performing.

## Absolute returns

Absolute returns measure the total increase or decrease in the value of your investment without considering the time period. It is a straightforward way to see how much your investment has grown in absolute terms for two points in time. This is also commonly known as point to point returns

Example:

If you invested Rs. 10,000 in a mutual fund and its value increased to Rs. 12,000 after one year, the absolute return is calculated as follows:

Absolute return = (Ending value − Beginning value) / Beginning value × 100
In this case,
Ending value = Rs. 12,000
Beginning value = Rs. 10,000

Therefore, the absolute return is:

Absolute Return = (12000 − 10000) / 10000 × 100 = 20%

So, the absolute return is 20%, meaning your investment has grown by 20% over the period.

## Compound annual growth rate (CAGR) CAGR

CAGR is a simple and widely used metric to calculate the average annual growth rate of investments generally held for more than a year. It smooths out the fluctuations in the returns over the investment horizon to arrive at one number. This gives a simpler view of the performance of your investment.

Example:
Suppose you invested Rs. 10,000 in a mutual fund three years ago, and now it has grown to Rs. 15,000. To calculate the CAGR, you can use a simple formula:

CAGR = (Ending Value / Beginning Value)1/n − 1

In this case,

Ending Value = Rs. 15,000
Beginning Value = Rs. 10,000
n = number of years (3 years)

So, the CAGR calculation would be:

CAGR = (15000 / 10000)⅓ − 1

This comes to approximately 14.47%. This means your investment grew at an average annual rate of 14.47%, even though the returns would have fluctuated year-on-year.

## Extended internal rate of return (XIRR)

XIRR is a more advanced method that accounts for cash flows. It is particularly useful when you make multiple investments of differing amounts and at intervals. XIRR provides a single rate of return for all these transactions.

Example:

Let’s say you invest Rs. 5,000 in January, another Rs. 3,000 in June, and Rs. 2,000 in December. After one year, your investment is worth Rs. 11,000. To calculate XIRR, you need to consider the dates of each investment. The Excel spreadsheet provides an easy way to calculate XIRR. Here are the steps to follow while calculating XIRR on MS Excel:

List all your cash flows in one column. Include both positive and negative values. Positive values represent cash inflows (like dividends), while negative values represent cash outflows (like SIPs).

List the corresponding dates of these cash flows in the adjacent column.

Use the following XIRR function in Excel: “=XIRR(values, dates)”

• values: The range of cells that contains the cash flows.
• dates: The range of cells that contains the corresponding dates.

Conclusion:

To make an informed investment decision, it is essential to understand the basics of mutual fund returns. By using methods like CAGR, XIRR, and Absolute Returns, you can get a broader view of how your investments are performing. Each method provides unique insights, helping you assess your mutual fund returns more accurately.

## FAQs

What is CAGR, and why is it important for assessing mutual fund returns?
CAGR shows the average annual growth rate of an investment over a specific period, helping investors understand the rate of return on annualized basis.

How is CAGR different from other return metrics?
CAGR provides a smoothed annual growth rate based on the initial investment, the final value and the investment period. XIRR is suitable for investments made in instalments. Moreover, it takes into investments, dividends as well as redemptions.

What distinguishes XIRR from other return calculations?
XIRR considers multiple investments made at different times, providing a single rate of return that accounts for the timing of each cash flow.

How does XIRR handle irregular cash flows in mutual fund investments?
XIRR takes into account the dates and the amount of cash flows (investments as well as redemptions) over a period of time. This can provide a more holistic picture of how an investment grew over time.

How are absolute returns different from relative returns?
Absolute returns measure the total percentage increase or decrease in value without considering the time period, while relative returns compare performance against a benchmark or index.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.