The XIRR, also known as the Extended Internal Rate of Return, is a method used to determine the average annualized return rate. It is an optimal method of return for the type of investments that includes SIP.
CAGR, which stands for Compound Annual Growth Rate, measures the average yearly growth of an investment during a defined period, assuming a consistent annual growth rate.
The CAGR method takes into account all the individual cash flows that occur throughout your investment duration when calculating the investment's rate of return.
XIRR represents the mean of annual returns obtained from an investment, with particular attention to the initial and concluding investment values.
=[( End Value of Investment/ Initial Value of Investment ) ^( 1/time period in concern )] – 1
= ∑CAGR of all installments
For CAGR, the tenure remains the same. XIRR depends on the installment period, the tenure can change.
CAGR evaluates the performances of the invested lump sum amount. XIRR only focuses on calculating the performance of the cash flow.
CAGR is not an ideal formula for short-term investments like 12 months. If you don’t include the final redemption value, then XIRR won’t be able to offer the yearly return rate.