Smart Tip: Understanding returns on investments

Jan 07 2013, 11:27 IST
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How many of us really understand the returns and their underlying purpose? (Reuters) How many of us really understand the returns and their underlying purpose? (Reuters)
SummaryHow many of us really understand the returns and their underlying purpose?

For investors, returns are the key indicators of their investment performance. But how many of us really understand the returns and their underlying purpose?

In mutual funds, NAV is the basic element used in calculating the returns because it keeps varying from one point of time to other.

Thus, the purchase and sale value of investment is derived by multiplying the units purchased with NAV for respective period i.e. purchase date and sale date. For a layman, surplus earned over and above the principal is often termed as returns.

Returns are often termed in value and percentage change. For instance, investment of Rs 10,000 appreciates to Rs 15,000 during the term of three years of value. It means that the principal has appreciated by Rs 5,000, while in terms of percentage change, it is 50 per cent appreciation. But can we term this percentage change as the only method to gauge the performance of mutual fund investments. No.

Calculating investment performance

Absolute Returns : Absolute returns are very easy to calculate as it measures the value of investment at one point of time with other. This is the most common method to interpret the investment performance. It is generally used to measure the performance of mutual funds with high equity exposure, whose NAV (Net Asset Value) fluctuates from time to time.

If fund is purchased at Rs 10 per unit and after three years, if NAV appreciates to Rs 18 per unit, here the absolute returns is 80 per cent.

Simple annualised returns: This is just an extension to absolute returns. It is an average annual return on investments over the period of time. The simple annualised return is used for those funds, whose NAV is less volatile or fluctuates less frequently. In mutual fund industry, simple annualised returns are used for debt, liquid and short-term funds for a period less than year, as there NAV is less volatile.

For instance, a debt fund is purchased at Rs 10 per unit, after three month NAV appreciates to 10.2 per cent after 3 months. The simple annualised return on the portfolio is 8.11 per cent.

PURCHASE OF R 7,000 THROUGH SIP OVER 1 YEAR IS ILLUSTRATED BELOW. (XIRR)

Date Amount (R)

20/09/2011 -7,000

25/10/2011 -7,000

25/11/2011 -7,000

26/12/2011 -7,000

26/01/2012 -7,000

27/02/2012 -7,000

26/03/2012 -7,000

25/04/2012 -7,000

25/05/2012 -7,000

26/06/2012 -7,000

25/07/2012 -7,000

25/08/2012 -7,000

28/08/2012 90,000

XIRR Return 15.69%

Absolute Return 7.14%

Total Cost 84,000

Total Value 90,000

Compounded annualised growth rate (CAGR): The CAGR

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