CAGR – It calculates the annualized returns on investment. It is suitable to be used when one time lumpsum investment and one time redemption is done in a mutual fund scheme. For example – An investor invests ₹ 1 lakh in a mutual fund scheme and redeems ₹ 2 lakhs at the end of 5 years. The CAGR in this case is 14.87%. There are several apps and websites wherein investor can enter the invested amount, redemption amount and duration of investment to calculate CAGR. If you go by the mathematical formula, compound interest formula can be used as below:
A = P (1 + r / n)nt
A = Current Market Value of Investment, P = Initial invested amount, r = rate of interest, n = number of times interest is compounded per year (the value is 1 for annualized return) and t = number of years of investment.
If we know other values, ‘r’ can be calculated. ‘r’ denotes CAGR or compound interest.
XIRR – Mutual fund investments are usually not done with one time investment and one time redemption. Investors usually have several periodic and non periodic investments through SIP and multiple lumpsum investments, and investor could have several redemptions as well. The annualized return for each investment and redemption done is different in this case. XIRR, or Extended Internal Rate of Return is one of the best parameter to calculate returns for investment in this case as it calculates the annualized returns of each investment, and combines them to have a single XIRR value. This is the best parameter for analyzing the performance of investment done.
Rolling Returns: While comparing the performance of mutual funds, if we look into the XIRR returns of 2 different funds in a 5 year period, the difference might be 7 percent on one particular day, and could be 1 percent a week later. So, XIRR may not give a clear picture for selection of mutual fund based on returns. In this case, rolling returns would be the right parameter for mutual fund selection. Let’s say we are comparing the rolling returns of 2 different funds, Fund A and Fund B for a 3 year period with starting date from 1st of January 2018 until 1st of January, 2024 (6 years duration).
The returns are calculated for each 3 year duration in this case and then averaged out. The returns are calculated from 01.01.2018 to 01.01.2021, then from 02.01.2018 to 02.01.2021 and so on until 01.01.2021 to 01.01.2024, and then averaged out. The same can be displayed in a chart comparing the performance of 2 funds.
This gives a proper understanding of how the funds have performed over years for each duration. This is the best parameter for comparison and selection of mutual fund schemes to invest, based on returns. One of the best website for comparison of rolling returns is advisorkhoj.com, which allows comparison of upto 4 mutual fund schemes at one go.
So, to conclude:
- CAGR is the parameter to calculate annualized return in case of one time investment and one time redemption.
- XIRR is the parameter to calculate annualized return in case of several investments and one time or several redemptions.
- Rolling return is the parameter that needs to be used for comparing mutual fund returns to opt the right one for investment.