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How to Read Mutual Fund Returns Correctly: Why CAGR, XIRR and Absolute Return All Matter
- Ripradaman R
- 5 days ago
- 3 min read
Introduction
Many investors look at returns but misunderstand what they represent.
CAGR, XIRR and absolute return are not interchangeable.
Each metric serves a specific purpose.
Reading them correctly can significantly improve investment decisions.
Absolute Return: The Simplest Metric
Absolute return shows total percentage gain over a period.
Formula:
(Final Value – Initial Investment) ÷ Initial Investment
Example:
Invested ₹1,00,000
Value becomes ₹1,20,000
Absolute return = 20%
Best used for:
Short-term investments
Periods below one year
Limitation:
Does not adjust for time
Cannot compare investments of different durations
Absolute return is straightforward but incomplete.
Interesting Read:
CAGR: The Annualized Growth Rate
CAGR (Compounded Annual Growth Rate) shows average annual return over multiple years.
It smooths volatility and reflects compounding.
Best used for:
Lump sum investments
Comparing multi-year performance
Evaluating long-term growth
Example:
If ₹1,00,000 becomes ₹1,33,100 in 3 years, CAGR is 10% per year.
Why it matters:
Reflects true annual growth
Helps compare funds fairly
Essential for long-term equity funds
However, CAGR assumes a single investment at the start.
XIRR: Ideal for SIP Investors
XIRR (Extended Internal Rate of Return) accounts for multiple cash flows.
Best used for:
SIP investments
Irregular investments
Withdrawals during holding period
Why CAGR fails for SIP:
Because SIP investments are made monthly, not at once.
XIRR adjusts for:
Timing of each installment
Compounding impact
Withdrawal effects
For SIP investors, XIRR is the most accurate performance metric.
Watch this video:
When to Use Which Metric
Use Absolute Return when:
Investment period is less than 1 year
Use CAGR when:
You invested lump sum
Time period exceeds 1 year
Use XIRR when:
You invested via SIP
You made staggered investments
Choosing the wrong metric leads to wrong conclusions.
Common Mistakes Investors Make
Comparing absolute return of 6 months with CAGR of 3 years
Using CAGR to measure SIP performance
Ignoring expense ratio impact
Focusing only on past returns
Ignoring risk-adjusted performance
Returns must always be evaluated alongside:
Volatility
Drawdowns
Fund consistency
Benchmark comparison
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Reading Mutual Fund Factsheets Smartly
When reviewing a fund:
Check 1-year absolute return
Check 3-year and 5-year CAGR
For SIP calculators, check XIRR
Compare against benchmark
Review rolling returns if available
Performance evaluation should be structured, not emotional.
Also Read:
Conclusion
CAGR, XIRR and absolute return each serve a distinct purpose.
Understanding when to use each metric prevents misinterpretation.
Smart investing is not about chasing the highest number.
It is about interpreting the right number correctly.
FAQ
Q1. Is CAGR better than absolute return?
CAGR is better for long-term investments because it accounts for time and compounding.
Q2. Should SIP investors use CAGR?
No. SIP investors should use XIRR because it adjusts for multiple investment dates.
Q3. Why do mutual fund apps show different return numbers?
Because they may display absolute return, CAGR or XIRR depending on investment type and duration.
Q4. What is a good CAGR for equity mutual funds?
Historically, 10–15% CAGR over long periods is considered strong, but it varies with market cycles.
Q5. Can absolute return be misleading?
Yes. It ignores time. A 20% return in one year is very different from 20% over three years.
Q6. Which metric should long-term investors focus on?
Primarily CAGR, but also review consistency, risk metrics and benchmark performance.
Citations
Association of Mutual Funds in India (AMFI)
Securities and Exchange Board of India (SEBI)
Morningstar India Research
Value Research Online
Investopedia Financial Definitions
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