SIMPLE RETURNS VS COMPOUNDED RETURNS:

1.SIMPLE RETURNS:

These are the reurns offered by instrument over a period of time.

Suppose Mr “A” have invested Rs.10,000 in Reliance Growth Fund at NFO at issue price of 10 in 1995.

As, we are taking it for concept only,we will ignore entry load etc.

Today NAV is  : 475.

so,Rs. 10,000 invested by Mr “A” has become today : 1000 x  475

                                                                                                     =   4,75,000.

Simple returns   =  (4,75,000 – 10000 / 10000) 

                               =  46.50       OR

                            = 4650 %

FOR SIMPLE RETURNS CALCULATION,,TERM IN YEARS IS NOT SIGNIFICANT.ONLY INITIAL AND FINAL VALUE HAVE IMPORTANCE.

SO THIS IS NOT CORRECT METHOD TO CALCULATE RETURNS OVER PERIOD LONGER TERM.

2. COMPUNDED ANNUAL GROWTH RETURNS:

THIS IS A REAL WAY TO CALCULATE THE RATE OF RETURNS OVER A LONGER PERIOD OF TIME.

E.g. If anyone says that equity market will give 15% CAGR  for next 10 yrs.

It means that Rs.100 invested in first year will be 115 in second year & which will considered as a principal for 2nd yr.

In this way,,Principal + interest generated till precceding year is input for next year.

If we calculate compounded annual returns for Reliance Growth fund since inception it comes to be :

CAGR = (simple returns ) raise to (1/n)  – 1

           = (46.5 )  raised to 1/16    –   1

          =  46.5 raised to 0.0625  – 1

         = 1.2712 – 1

       = 27.12%

THIS IS THE REAL RATE OF INTEREST AS WE CALCULATE INFLATION ON CAGR BASIS RETURNS OFFERED BY INSTRUMENTS HAVE TO BE CALCULATED IN SIMILAR WAY.