XIRR (Extended Internal Rate of Return) and CAGR (Compound Annual Growth Rate) are methods to measure mutual fund returns. While CAGR shows steady growth for a lump-sum investment, XIRR is useful for tracking returns on multiple investments made at different times.
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What Is XIRR In Mutual Fund?
XIRR, or Extended Internal Rate of Return, is a method to calculate returns on investments made at different times. It’s particularly useful in mutual funds where systematic investments, like SIPs (Systematic Investment Plans), involve recurring contributions rather than a single deposit.
Unlike CAGR, which calculates returns based on a one-time investment, XIRR takes into account multiple cash flows by considering each deposit or withdrawal date. This makes XIRR more accurate for investments with irregular inflows and outflows, giving investors a clearer picture of actual returns.
In mutual funds, XIRR provides a personalized return rate, adjusting for the timing of each investment. For investors using SIPs or making lump-sum additions at various intervals, XIRR is a reliable measure to understand overall performance across different time frames.
What Is CAGR In Mutual Funds?
CAGR, or Compound Annual Growth Rate, is a metric used to measure the average yearly growth of a one-time investment in mutual funds over a specified period. It represents a consistent growth rate, simplifying returns into a single, comparable value.
In mutual funds, CAGR is useful when evaluating the growth of a lump-sum investment, as it assumes that earnings are reinvested each year. This makes CAGR a helpful tool for comparing the steady growth rates of different funds or investments over time.
However, CAGR doesn’t account for additional investments made at various times, like SIPs. It’s best suited for single-sum investments where no additional contributions or withdrawals occur, providing a snapshot of the fund’s overall performance.
Difference Between XIRR and CAGR
The main difference between XIRR and CAGR lies in their approach to returns. While CAGR calculates growth on one-time investments, XIRR accounts for multiple transactions, making it ideal for SIPs and other irregular investments.
| Aspect | XIRR | CAGR |
| Definition | Calculates returns for investments with multiple cash flows at different times | Measures consistent annual growth on a single lump-sum investment |
| Best for | Ideal for SIPs, or any investments with regular or irregular contributions | Best suited for one-time or lump-sum investments |
| Accuracy | Offers a precise return rate by factoring in every transaction date | Provides an average growth rate but ignores the effect of multiple investments |
| Ease of Comparison | Effective for personalized return calculation; complex to compare directly with others. | Simple, standardized metric for comparing lump-sum investments across funds |
XIRR Formula
XIRR, or Extended Internal Rate of Return, is a method to calculate returns when you make multiple investments over time, like with SIPs in mutual funds. XIRR finds a single return rate that considers the timing and amount of each transaction. It’s especially helpful because regular and irregular investments can affect your overall returns and XIRR gives a clearer picture of how well your investment has grown.
In Excel, the XIRR formula is used to calculate the rate of return for investments with multiple cash flows on different dates. The formula syntax is:
=XIRR(values, dates, [guess])
Here’s what each part means:
- Values (required): This is an array or range of cash flow values, where investments (deposits) are positive and withdrawals (or the final investment value) are negative. Each value represents a different cash flow event.
- Dates (required): This is an array or range of dates corresponding to each cash flow in the Values array. The first date represents the start date of the investment and each subsequent date must be later than the previous one.
- [Guess] (optional): This is an initial estimate of what the XIRR will be, which helps Excel’s calculation. If omitted, Excel assumes a default guess of 10%.
Excel uses an iterative process to find the XIRR, adjusting the rate until the result is accurate to within 0.000001%. This makes it efficient for calculating returns on investments with complex cash flow schedules.
CAGR Formula
The CAGR (Compound Annual Growth Rate) formula is used to calculate the average annual growth rate of an investment over a specified period. It’s useful for measuring steady growth on a lump-sum investment. Here’s the formula:
CAGR =(Ending balance/beginning balance)1/n – 1
Here’s what each part means:
- Ending Value: The final value of the investment at the end of the period.
- Beginning Value: The initial value of the investment at the start of the period.
- Number of Years: The total duration of the investment, in years.
The formula calculates a single growth rate that, if applied each year, would result in the investment’s beginning value growing to its ending value over the given period. It gives a “smoothed” growth rate, assuming consistent growth each year, even if actual growth varies.
Advantages and Disadvantages of CAGR
The main advantages of CAGR include its simplicity and effectiveness in showing average growth over time, making it ideal for comparisons. However, it has limitations, such as overlooking volatility and being best suited for single investments.
| Advantages | Disadvantages |
| Easy to Understand | Ignores Market Fluctuations |
| CAGR simplifies growth into a single percentage, making it accessible to all investors, including beginners. | CAGR does not reflect the impact of market volatility, which can mislead investors about potential risks. |
| Effective for Comparisons | Limited to Lump-Sum Investments |
| It provides a consistent rate for comparing various investments, helping investors evaluate their performance efficiently. | CAGR is most suitable for one-time investments, making it less useful for investments with multiple cash flows. |
| Clear Performance Indicator | Assumes Constant Growth Rate |
| CAGR provides a clear indicator of an investment’s performance over time, making it useful for long-term planning. | The assumption of constant growth may not accurately represent actual investment performance, which can vary from year to year. |
Advantages and Disadvantages of XIRR
The main advantages of XIRR include its accuracy in accounting for multiple cash flows and its ability to provide a personalized return rate. However, it can be complex to calculate and may not be suitable for investments without varied cash flows.
| Advantages | Disadvantages |
| Accurate for Multiple Cash Flows | Complex to Calculate |
| XIRR provides precise returns by factoring in the timing and amount of each cash flow, enhancing accuracy. | The calculation of XIRR can be complicated, often requiring spreadsheet software, which may be challenging for some investors. |
| Reflects Actual Investment Performance | Less Effective for Steady Investments |
| It gives a clearer picture of how various investments perform over time, especially for SIPs or staggered investments. | For investments with consistent cash flows, XIRR may be less beneficial compared to simpler metrics like CAGR. |
| Personalized Return Rate | Sensitive to Cash Flow Timing |
| XIRR allows investors to see returns based on their unique investment patterns, leading to better decision-making. | XIRR results can be highly sensitive to the timing of cash flows, which may lead to misleading conclusions if not analyzed carefully. |
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Difference Between XIRR and CAGR – Quick Summary
- XIRR calculates returns on investments with multiple cash flows, providing a more accurate measure for mutual funds and SIPs compared to CAGR, which uses a single investment.
- CAGR measures the average annual growth of a one-time investment in mutual funds, ideal for comparing funds but unsuitable for investments with multiple cash flows.
- XIRR accounts for multiple cash flows in investments, ideal for SIPs, while CAGR measures consistent growth for single lump-sum investments, simplifying comparisons.
- XIRR calculates returns for multiple investments over time, considering transaction timing and amounts, using the Excel formula =XIRR(values, dates, [guess]) for precise results.
- CAGR measures the average annual growth of an investment using the formula CAGR = (Ending Value/Beginning Value)^(1/n) – 1, assuming consistent yearly growth over a specified period.
- CAGR is simple and effective for comparing average growth, but it overlooks volatility, is best for lump-sum investments and assumes constant growth rates.
- XIRR accurately accounts for multiple cash flows and provides personalized returns, but it can be complex to calculate and less effective for steady investments.
XIRR Vs CAGR – FAQs
XIRR (Extended Internal Rate of Return) and CAGR (Compound Annual Growth Rate) are both metrics for measuring investment returns, but they differ in their applications:
The main difference between XIRR and CAGR lies in:
Cash Flow Handling: XIRR calculates returns for multiple cash flows at different times, while CAGR measures the growth of a single lump-sum investment over time.
Complexity: XIRR is more complex and requires tracking cash flow timings, whereas CAGR is simpler and provides an average growth rate.
Use Cases: XIRR is ideal for systematic investments (like SIPs), while CAGR is suited for comparing single investments.
Accuracy: XIRR reflects returns more accurately in dynamic scenarios, while CAGR provides a generalized growth rate, potentially overlooking fluctuations.
A good XIRR typically ranges from 8% to 15% for mutual fund investments, depending on market conditions. However, a “good” XIRR varies by investor goals, risk tolerance and the investment’s time horizon, with higher rates indicating better performance.
To calculate the Compound Annual Growth Rate (CAGR), use the formula:
CAGR =(Ending balance/beginning balance)1/n – 1
Beginning Value: The initial investment amount.
Ending Value: The final amount after the investment period.
Number of Years: Total duration of the investment in years.
Plug Values: Substitute the values into the CAGR formula.
Calculate: Perform the calculation to find the CAGR, indicating the average annual growth rate.
The formula to calculate XIRR is:
=XIRR(values, dates, [guess])\text{=XIRR(values, dates, [guess])}=XIRR(values, dates, [guess])
Arguments:
Values: Required; an array or range of cash flows (positive for income, negative for investments).
Dates: Required; corresponding dates for each cash flow, with the first date as the start date.
[Guess]: Optional; an initial estimate of the IRR (default is 10% if omitted).
Excel uses an iterative method, adjusting the rate starting from the guess until the result is accurate to 0.000001%.
Yes, CAGR can be negative. For example, if an investment of ₹1,00,000 decreases to ₹80,000 over three years, the CAGR would be negative, indicating an average annual loss in value, reflecting a decline in the investment’s performance.
Yes, you can convert XIRR to CAGR by adjusting the cash flows. For instance, if an investment of ₹1,00,000 grows to ₹1,50,000 over three years with an XIRR of 14.5%, the CAGR would reflect this growth as an average annual rate.
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Disclaimer: The above article is written for educational purposes and the companies’ data mentioned in the article may change with respect to time. The securities quoted are exemplary and are not recommendatory.
