Calculating SIP Returns

It’s a hot summer day, and your teacher just introduced the concept of percentages in your mathematics class. You feel empowered because all those weird symbols and rush at the shopping malls during discount seasons start to make sense. A few months pass by, and a chapter called profit and loss is introduced and brings with it the concept of money. Now you could calculate how much money a shopkeeper makes on a particular investment and what would be loss or profit margin for the same using simple arithmetic operations. The returns calculated through this method are known as absolute returns but this method has problems that render it unusable in real-world investments. This blog focuses on countering that problem.

The problem with absolute returns

Absolute returns are a great way to show how much has the money grown? But fails to answer how this money has grown? I.e., it does not consider the time for which the money remained invested. This can be an essential factor for a long-term investor to compare different companies or funds.

CAGR (Compounded Annual Growth Rate)

CAGR is the compounded annual growth rate of an investment.

CAGR answers the question, how has the money grown? by including the component of time in its calculation. It is one of the best methods to calculate the returns on a lumpsum investment. It gives a much more realistic picture of annual returns than its counterpart annualized returns.

CAGR=VfinalVinitial1t-1

The problem with CAGR

CAGR might be great for the calculation of returns on a lumpsum investment but fails in the case of a periodic investment like SIP or RD as it doesn’t take into account the time for which a fraction of money stays in the market and instead treats the entire corpus as a one-time investment.

XIRR (Extended Internal Rate of Return)

The XIRR gives a single rate of return when applied on all the investments and yields the current investment amount.The IRR(Internal Rate of Return) solves the problem of determining how the investment has grown in the case of investments distributed over a period of time. However, the IRR can only be used to calculate the returns on investments done at regular intervals, which might not be the case in many scenarios. XIRR solves this problem and can consider all the assets and withdrawals done at regular or irregular periods.

How to calculate XIRR?

Calculating XIRR is much more complex than the other returns, and thus, investment advisors and even CAs use excel for calculating the same.

Calculating XIRR is much more complex than the other returns, and thus, investment advisors and even CAs use excel for calculating the same.

Steps:

• Make a column each for date and amount.
• Put a negative sign on the invested amount and a positive signal on the received return.
• Select any other cell and type “=xirr(“entire amount range”,” date range”)”
• Format the cell as a percentage to get the XIRR.

To understand these terms better, let’s take an example of a regular monthly SIP in a hypothetical fund and calculate the absolute return, CAGR, and XIRR at the time of redemption.

This was some information on how to calculate the returns on a particular investment, and we hope this proves helpful the next time you compare different investment opportunities. We’ll be back with some more information.

Till then, Stay safe! Invest Safer!

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