The secret to creating a stable financial future is wise investing. One of the easiest and smartest ways to grow your wealth is through a Systematic Investment Plan (SIP).
With SIP investments, you can regularly invest a fixed amount in mutual funds, helping you achieve your long-term financial goals without needing a large lump sum.
However, many investors often wonder what kind of returns they can expect from SIPs. This blog will explore the basics of SIP interest rates and how to estimate average returns using tools like the SIP calculator.
What is SIP Investment?
One methodical way to invest in mutual funds is using a Systematic Investment Plan (SIP). Instead of investing a large sum all at once, an SIP allows you to invest small, fixed amounts regularly, usually monthly.
This strategy helps you build your wealth gradually and reduces the risk of market volatility. By investing consistently over time, you can take advantage of rupee cost averaging, which helps you buy more units when prices are low and fewer units when prices are high.
Understanding SIP Returns
When you invest in mutual funds through SIPs, you grow your money through compounded returns. The returns you earn on your investment are reinvested, which helps generate additional returns over time. However, what sort of returns are you likely to get? To understand this, you must know different ways to measure the performance of SIP investments.
Let’s Understand SIP Calculator
It is an online tool through which investors can forecast the future value of their SIP mutual fund assets. By entering the monthly investment amount, investment duration, and expected rate of return, the SIP calculator provides an estimate of the total wealth one can accumulate over time.
For instance, if you decide to invest ₹5,000 every month for 10 years with an expected annual return of 12%, the SIP calculator will show you the projected value of your investment. This tool simplifies financial planning, helping you set realistic goals and understand the growth potential of your SIP investments.
How Does the SIP Calculator Work?
The SIP calculator uses a simple formula to compute the future value of your SIP investments, taking into account the power of compounding. Here’s how it works:
- Enter the monthly fixed amount that you intend to invest.
- Specify the number of years or months you intend to continue the SIP.
- Input the anticipated annual return rate based on the mutual fund’s past performance.
The SIP calculator then applies a formula to determine the compounded growth of your investment, giving you a clear idea of the potential returns.
How to Calculate Returns on SIP Investments?
To understand the growth of your SIP investments, you can use different methods to calculate returns. Let’s look at three popular methods:
1. Absolute Return
Without taking time into account, the absolute return calculates the overall percentage growth or reduction in your investment. It is a simple way to calculate how much your money has grown in percentage terms.
Formula:
Absolute Return = (Current Value−Invested Amount) x 100
Invested Amount
For example, if you invested ₹1 lakh and its current value is ₹1.2 lakh, the absolute return would be 20%.
When the investment time is smaller than a year, absolute return is helpful. Still, it may not be the best indicator for long-term SIP investments.
2. Compounded Annual Growth Rate (CAGR)
The Compounded Annual Growth Rate (CAGR) gives a better picture of your investment’s performance over a longer period. It displays the investment’s average annual growth rate as per the effect of compounding.
Formula:
CAGR = End Value of Investment 1/(number of years) – 1
Initial Value of Investment
CAGR smooths out the returns over time, making it easier to compare the performance of different investments. It is ideal for understanding how much your SIP investments grow on average each year.
3. XIRR (Extended Internal Rate of Return)
The XIRR method provides the most accurate measure of returns for SIP investments, which involve regular over-time investments. Unlike absolute return and CAGR, XIRR considers the timing and frequency of cash flows, making it ideal for SIPs.
XIRR uses the specific dates of your investments and calculates the discount rate that sets the net present value of all cash flows to zero. In simpler terms, it helps you find the average annual rate of return on your SIP investment, taking into account the regular contributions.
XIRR is particularly useful when your SIP contributions are not consistent or if you have made additional investments or withdrawals during the period.
Conclusion
A wise and practical strategy to increase your wealth over time is to invest using a Systematic Investment Plan (SIP). An SIP calculator can help you plan your investments effectively and give you a realistic estimate of the expected returns.
