XIRR is a method used to compute annualised returns from mutual funds applicable for investments made via systematic investment plans (SIPs). It is a single rate of return applicable for every SIP instalment and redemption.
XIRR in mutual funds gives the annual average return for each SIP instalment. Unlike CAGR, it accounts for irregular cash flows and multiple periods, making it an essential tool for analysing mutual fund returns.
The advantages of XIRR are as follows:
XIRR helps you measure the performance of your mutual fund investments more accurately. This is because it factors in the exact timing of cash flows. Also, since it considers withdrawals, it helps you measure the performance of your mutual funds in a more nuanced manner.
XIRR factors in the time value of money by factoring in specific dates and cash flows. Thus, it helps you evaluate the actual return on your investment.
XIRR enables you to compare returns across various investment avenues like mutual funds, fixed deposits, or real estate. Since it standardises returns by accounting for timing and cash flow variations, you can make informed decisions by evaluating which option has delivered better real-world returns over time.
XIRR allows you to track the overall performance of your portfolio even if it includes multiple funds and irregular transactions. By consolidating all cash inflows and outflows with their respective dates, it gives a single annualised return figure, making portfolio performance easier to understand and monitor.
XIRR requires you to input accurate and complete cash flow data. This includes the date and amount of each cash flow. If you input incomplete or inaccurate data, it can affect the calculation.
XIRR is a sensitive metric. Even minor alterations in cash flow data can make it challenging to compare different funds based solely on XIRR returns.
XIRR is a retrospective metric that calculates historical performance based on past cash flows. It does not account for future market conditions, making it unsuitable for forecasting future returns or making forward-looking investment decisions.
XIRR can produce misleading or exaggerated results when applied to very short-term investments with limited transactions. Since it's an annualised figure, a small gain over a few days can show an inflated return, making it harder to assess real performance over short periods.
You can quickly compute XIRR in MS Excel using the XIRR function. The formula to calculate XIRR in Excel is:
=XIRR (Values, Dates, [Guess]), where
To calculate XIRR in Excel:
Assuming you start an SIP of ₹10,000 on 10th January 2023 and continue investing the same amount throughout the year on the same date. As of 10th December 2023, your maturity amount is Rs 1.3 lakhs. In this case, the XIRR of your investment stands at 18.4% (see image below).
CAGR Meaning
CAGR is used to calculate the annualised return of your mutual fund investment when cash flow occurs at regular intervals. Assuming a constant growth rate over a specific period, it computes the average rate of returns during that period.
CAGR is most effective when there is a single investment and a single redemption, such as in lump sum mutual fund investments. It smooths out the volatility in returns by assuming steady growth, which helps you understand how your investment would have grown if it had progressed at the same rate every year.
CAGR Advantages
CAGR in mutual funds offers the following advantages:
CAGR is a simple metric that even beginners can understand. It shows the average annual growth rate of an investment over a set period. Since it assumes a steady growth path, it eliminates the complexity of daily market fluctuations, making performance evaluation more straightforward and consistent across different investment options.
CAGR allows you to compare the historical performance of various mutual funds over identical time frames. This standardisation helps in objective fund selection by offering a clear picture of past returns. Whether comparing equity or debt funds, CAGR gives a uniform benchmark for evaluating long-term investment outcomes.
CAGR is particularly useful for evaluating long-term investments, as it smooths out short-term market volatility. It provides a realistic view of how your investment has grown annually over time, making it ideal for assessing mutual fund performance over 3-, 5-, or 10-year periods and supporting informed financial planning decisions.
CAGR Limitations
CAGR assumes that the investment grows at a steady, uniform rate throughout the specified period. In reality, market movements are rarely consistent and returns often vary significantly year to year. This assumption can oversimplify actual performance and may mislead investors about the risks or irregular growth patterns in their investments.
CAGR masks the ups and downs experienced during the investment period by presenting a smoothed average return. This can be misleading for investors, as it hides periods of sharp declines or exceptional gains. As a result, it does not provide a complete picture of the investment’s risk or real-time behaviour.
CAGR is designed for scenarios with a single investment and a single exit point. It does not account for multiple transactions like SIPs, withdrawals, or top-ups. For mutual fund investments involving regular or irregular cash flows, XIRR is a more accurate measure than CAGR.
Use the following formula to calculate CAGR:
CAGR = [(End Value/Beginning Value) ^ (1/No. of years) - 1] x 100
Suppose you invested ₹50,000 in a mutual fund, and the value of your investment has grown to ₹1 lakh in 5 years. CAGR, in this case, would be 14.87%. There are online CAGR calculators that help you easily calculate CAGR.
While you can use XIRR and CAGR to analyse the performance of your mutual fund investment over a period, the similarity ends here. The table highlights the differences between them on various parameters:
Parameter | XIRR | CAGR |
---|---|---|
Definition | Extended Internal Rate of Return; annualised return accounting for exact dates and amounts of cash flows | Compound Annual Growth Rate; assumes a fixed annual growth rate over a period |
Cash Flow | Factors in multiple and irregular cash flows | Assumes a single lump sum investment and final redemption |
Timing | Considers the exact timing of each cash inflow and outflow | Ignores timing; only start and end values are considered |
Precision | Highly accurate as it reflects real-world scenarios | Less accurate in dynamic investment environments |
Complexity | More complex to calculate; requires date-wise cash flow data | Simple to calculate using beginning and ending values |
Volatility Handling | Reflects actual market ups and downs over time | Smoothens volatility, assumes steady growth |
Use Case | Ideal for SIPs, top-ups, and irregular transactions | Best suited for one-time lump sum investments |
Interpretation | Offers a more realistic view of performance, especially for active portfolios | Gives a clean annualised figure but may be misleading with volatility |
Tool Requirement | Needs Excel or mutual fund platforms with date-wise data input | Can be calculated manually or with a simple formula |
Suitability | Suitable for evaluating real investor experience | Suitable for comparing fund performance with fixed holding periods |
Decision-Making Value | Helps in understanding portfolio-level returns more holistically | Helps in benchmarking long-term growth over fixed periods |
As previously highlighted, CAGR shows the average annual growth and works well for a lump sum investment. Therefore, it doesn’t account for multiple cash flows. XIRR, on the other hand, factors in the timing and amount of each SIP instalment, giving a more accurate picture of returns. Thus, for evaluating SIP returns, XIRR is generally the better metric.
For SIP investments: XIRR accounts for multiple instalments made at different times, unlike CAGR which assumes a one-time investment.
Irregular cash flows: If you invest or withdraw money at irregular intervals, XIRR gives a more accurate return than CAGR.
Multiple redemptions: When there are partial redemptions or withdrawals over time, XIRR captures the impact better.
Realistic return tracking: XIRR reflects actual investment behaviour, making it useful for tracking real-world returns in mutual funds or portfolio analysis.
Lump sum investments: CAGR works best when the entire investment is made at once and held over a fixed period.
Simple return analysis: If you are looking for a straightforward measure of growth over time without multiple cash flows, CAGR is ideal.
Benchmark comparisons: It is commonly used to compare the long-term performance of mutual funds, stocks, or indices.
Consistent holding periods: When there are no additional investments or withdrawals, CAGR provides a clear picture of annual growth.
Depending on how you invest – whether through lump sum or systematic plans – you can choose between XIRR and CAGR to evaluate returns. Both metrics have their own strengths and limitations. CAGR offers a straightforward way to assess the growth of lump sum investments over time. However, if your investments involve multiple transactions, such as SIPs or redemptions at irregular intervals, XIRR provides a more accurate and comprehensive view.
Read more:
What is CAGR in Mutual Funds?
Dividend vs Growth Mutual Fund
This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their own research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.
Investments in securities market are subject to market risks, read all the related documents carefully before investing. Brokerage will not exceed SEBI prescribed limit. The securities are quoted as an example and not as a recommendation. SEBI Registration No-INZ000200137 Member Id NSE-08081; BSE-673; MSE-1024, MCX-56285, NCDEX-1262.
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