How are Returns Calculated in SIP

When you think of investing, one of the first few investment instruments that you may think of is mutual funds. Moreover, what makes it so popular is its versatile structure.

In mutual funds, you can either park a lumpsum amount in a scheme or go for a more systematic approach, i.e., the SIP route. Irrespective of the route you choose, you should a have an idea of how much returns you would earn a couple of years down the line from your investment? Such calculations keep you well informed whether you are on the right track towards your financial goal. Now, when you opt for a lumpsum investment, you invest in units at one single net asset value (NAV). Calculating returns from such an investment seems like an easy job. However, this is not the case with SIP investments. Your SIP investment is done at fluctuating NAVs. It is relatively more complex to calculate returns in this case due to the series of instalments and changing NAVs associated with each instalment. So, how do you find out the returns on both these investments?

Additional Reads: What is a SIP and why is it Beneficial for You

Methods to Calculate SIP returns are:

Absolute return or Point-to-Point method

You can use this straightforward method to calculate the returns from the start point to the endpoint of your mutual fund investment. To use this method, you must apply the following formula:

Absolute Return = {(Final NAV – Initial NAV) / Initial NAV} * 100

Example: Let us assume you started a lumpsum investment where the NAV was Rs. 75 at the start. A couple of months into the investment, the NAV rose to Rs. 100. The Absolute Returns, in this case, will be:

{(100-75)/75}*100

= 33.33%

Similarly, you can also use this method to calculate the returns using the initial investment amount and the value of your investment at the end. This method is easy to use and preferred where the investment tenure is under a year. One significant drawback of this method is that it disregards investment tenure. For instance, in the above example, you cannot assess whether the 33.33% was earned over a year, or two, or three, and so on. Time plays a centre-stage role in comparing schemes based on the returns they offer within a said duration. However, this method will not inform you about the pace at which your investment has garnered x% returns.

Compounded Annual Growth Rate (CAGR) method

The CAGR method takes care of the shortcomings of the Absolute Return method. It factors in the investment tenure to give you the average annualised growth of the investment. In other words, the CAGR method calculates a steady rate of return at which your investments grow each year. It overlooks the volatility your investment goes through and only reflects the average rate of return throughout your investment tenure. To find out the returns using this method, you must apply the following formula:

CAGR = {(Final Value of Investment / Initial Investment Amount) ^ (1/n)} -1

Here, n = number of years

If your investment tenure is in months, you can divide the no. of months by 12 to convert the tenure in years.

Let us understand the CAGR method better with the help of the following example. Let us assume, you invested Rs 10,000 in a lumpsum mutual fund investment for three years. The NAV at the start of your investment was Rs. 25. Three years into the investment, the NAV rose to Rs. 50. The CAGR returns, in this case, will be:

{(50 / 25) ^ (1/3)} -1

= 25.99% or approximately 26%

The above method is advisable to be used only for lumpsum investments. To calculate the CAGR from SIP investments you can use XIRR function on MS Excel.

Extended Internal Rate of Return (XIRR) method

XIRR factors all the aspects of every SIP instalment, including the instalment amounts, the instalment dates, the investment maturity date, the cash inflows, and outflows. XIRR is a Microsoft Excel Function that calculates the CAGR to give you one consolidated SIP return rate.

In a SIP investment you invest a predefined amount at a set frequency. Each instalment fetches you a certain number of mutual fund units based on the NAV of that day. Your corpus of units keeps adding up, and accordingly, your returns may also increase. You can redeem the total units at the ongoing NAV and earn lumpsum returns.

Using this XIRR method is easy as Excel computes its complete calculation using the data points you provide. These include the SIP amount, the SIP instalment dates, the investment redemption date, and the redemption amount. This method does not require you to keep a record of any NAVs.

An example will help you understand easily how this method can be used in Excel.

Let us assume you have invested in a SIP, where the monthly instalment amount is Rs. 10000. You make timely payments starting from 1January 2021 for the next 12 months in a row. You redeem your investment a year later, on 1January 2022, and earn a maturity amount of Rs. 150000.

In this method, the instalments you pay are treated as cash outflows and must have a minus (-) prefix before the amount. Conversely, the redemption amount is an inflow to you. Hence, it must not have minus prefix.

To calculate the returns, you can earn in the above example, you have to mention all the SIP instalment dates in one column along with the instalment amounts in the adjacent column. In the row below the last instalment date, type the investment maturity date along with the maturity amount in the adjacent column.

It will look like this in MS Excel,

Now you need to only type in the XIRR formula in a blank cell, i.e., = XIRR (value, dates, guess). Select the respective columns against the ‘Value’ and ‘Dates’ fields. Leave the ‘Guess’ field blank and click on ‘OK’. Excel will instantly give you the SIP return rate of 48.9%.

If this seems like a complicated thing, you can always let a SIP calculator do the job for you. Simply punch in different combinations of instalments amounts, tenures, and expected return rates to see the future value of the investment at the end of the investment term.

Additional Read: How to Make the Best Use of SIP Calculator (Systematic Investment Plan)

How To Calculate Mutual Fund Returns @ICICIdirectOfficial

Conclusion

As a thumb rule, never enter a mutual fund investment blindly. Always know the risk and expected returns you can earn from an investment in advance and compare products. Knowing how much returns you can earn from an investment always helps in managing your investment decisions.

Additional Read: Is it normal if SIP returns are low in the initial years?