If you invest in mutual funds, you must have come across terms like CAGR, XIRR, and Absolute Returns. These are the methods used to calculate returns on mutual fund investments. Calculating returns through CAGR will not give precise results if you invest through monthly SIP. CAGR is adequate for calculating how your investments perform over time, but it only works on lump sum investments.
XIRR can effectively calculate returns when multiple transactions are happening in the portfolio. Now, the question is, how do we use it in our portfolio? Before we proceed with how to apply XIRR in mutual fund to calculate our returns, let’s understand the meaning of xirr or what is xirr in mutual fund. To understand XIRR meaning in mutual fund, we must first understand the meaning of IRR and CAGR.
What is IRR?
IRR stands for Internal Rate of Return. It is very closely tied to the NPV (Net Present Value). IRR considers the discount rate needed to produce an NPV of 0 for the investment. It is the rate of growth that your investments will generate. The formula to derive IRR is:
‘Value’ here stands for the amount invested or withdrawn from the funds.
‘Guess’ stands for the digits that you select close to the result of the IRR.
What is CAGR?
CAGR stands for Compound Annual Growth Rate. It is most commonly used to assess a fund’s entire performance. It presents a fund’s average annual growth or decline. CAGR shows compounded growth over some time. The formula to calculate CAGR is:
CAGR = (Final Investment Value/Initial Investment Value)^1/n – 1
Wherein n stands for the number of years. While IRR can be used to calculate periodic investments, which makes it restrictive since an investor invests and withdraw as per their convenience, and CAGR is the tried and tested way of calculating compounded growth of your investments over some time, it does not accurately calculate the rate of return on an investment made through multiple inflows and outflows. Therefore, a better way to calculate the rate of returns on your investments in mutual funds is XIRR.
What is XIRR in mutual fund?
The full form of XIRR is the Extended Internal Rate of Return. It is the technique used to calculate returns on investment in a mutual fund when there are multiple transactions. XIRR in mutual fund helps you calculate a consolidated return considering the timings of your investment and withdrawals. XIRR return means the rate of return determined by considering all the inflows and outflows made by the investor, not just the lump sum investment.
How to calculate XIRR
Digits needed to calculate XIRR:
- Date of the investment
- Amount invested
- Amount withdrawn
- Date of withdrawal
Let’s have a look at the following example to understand the xirr calculator for sip better.
|Date||Invested Amount (INR)|
Here’s how the XIRR calculator sip can determine the rate of return on our investment.
Go to an excel sheet and type the formula
=XIRR, you will get =XIRR(values,dates,[guess])
The formula mentioned above stands for:
- Values are the array of values that represent the series of cash flows.
- Dates are the series of dates that correspond to the given values. The first date is when you start the investment, and subsequent dates are future dates for outflow or inflows.
- Guess is an initial guess or estimate of what the IRR (Internal Rate of Return) will be. It is optional; however, if we omit Excel takes the default value of 10%.
In the given an example,
The value of XIRR, with the help of the formula, will be 40.4%. It signifies that if you had invested INR 50,000 on five different dates and liquidated your portfolio at today’s price of 3,50,000. Now, if you withdraw on a particular date, you are required to put that date and enter the value in positive as it’s a withdrawal. Everything else in the procedure stays the same.
With the help of the tool explained above, you can easily calculate XIRR and understand the exact rate of growth that has happened in your investments while you continued investing through SIPs or withdrew money.
Comparing the different methods
- Absolute Returns are a measure of absolute growth. CAGR is a measure of compounded growth. However, XIRR is the average rate earned by every cash flow invested during a particular period.
- Absolute Returns and CAGR do not take into account multiple cashflows. Whereas, whereas XIRR accounts for multiple cash flows.
- CAGR and Absolute Returns only consider two cashflows: at the time of investment or at the time of redemption. On the contrary, XIRR allows cash flows any number of times, irrespective of whether it’s an infusion or a withdrawal.
- CAGR and Absolute Returns are only suitable for lump sum investments. On the other hand, XIRR is suitable for both SIP and lumpsum investments.
An investor invests with the motive of growing their money. It can only be done using the right tools at the right time. It is essential to keep track of your investment’s growth rate to manage it better. If there is a requirement to calculate absolute growth, absolute returns should be considered.
A CAGR will be helpful if there is a need to assess compounded growth of investments made. When there are multiple cash flows in an investment, whether through SIPs or at random, XIRR is the best way to measure the performance of that investment.