If you are planning on investing in mutual funds for a longer duration, feel free to consider doing so via the Systematic Investment Plan. Also referred to as SIP, a Systematic Investment Plan is probably the simplest and easiest way to invest in mutual funds. Investors can start with a low sum and gradually increase their investments using SIP.
To understand how returns are calculated in SIP, investors first need to understand how SIP works. When you invest in fixed mutual funds via SIP, every month you buy some units with that sum. The allocation of units also depends on the scheme’s current Net Asset Value (NAV). For example, if you are investing Rs 500 every month in a mutual fund scheme and its current NAV stands at Rs 10 then you will be allotted 50 units. If the NAV falls to Rs 5 you will be allotted 100 units.
There are three possible ways in which you can calculate potential returns generated from SIP.
Absolute Returns
You can use the absolute returns formula to determine how much money you have earned or lost in the past year. It is a pretty simple and straightforward approach to calculate returns. You can use the absolute returns formula to track your point on point investment growth in the past year.
To calculate absolute returns, you have to follow the following formula –
Absolute return = [(Final NAV – Initial NAV) / Initial NAV]*100
Here’s an example to help you understand better.
Assume that the initial NAV of your investment is Rs. 50. This grows to become Rs. 60. This means that the absolute return on your investment would be:
Now let us use this same formula for your invested sum. Suppose you invested Rs 50000, and it increased to be Rs 70000. Then the absolute returns on your investments would be –
CAGR (Compounded Annual Growth Rate)
CAGR is slightly different than absolute returns for calculating SIP returns. While the absolute method does not take investment tenure into consideration while computing returns, the CAGR method does.
Here is the formula for calculating SIP returns using CAGR –
CAGR = [(Final investment value / Initial investment value)^(1/n)] – 1
Here’s an example for easy understanding –
Assume that you invested Rs. 2,00,000 in a mutual fund of your choice. This amount grew to Rs. 2,50,000 over 10 years. The CAGR will be calculated as follows:
XIRR (Extended Internal Rate of Return)
These days all mutual fund aggregators use XIRR to show investors their portfolio’s overall returns. You need to use Microsoft Excel to calculate returns from mutual fund investments via SIP with the XIRR formula. XIRR is recommended as it gives a clearer picture to the investor.
