After investing a specific sum of money in mutual funds, you may want to withdraw the earnings against your investments after a certain period, for instance, let’s say five years. At that point, you calculate your returns based on the amount invested initially and the maturity amount.
But if there are multiple cash flows, for example, in the case of an SIP (Systematic Investment Plan) investment, point to point returns can be misleading. Instead, to calculate returns on investments wherein various transactions are taking place at different intervals, one can use XIRR (Extended Internal Rate of Return).
XIRR stands for Extended Internal Rate of Return. It is a method that you can use to calculate returns on your mutual fund investments made at irregular intervals. Applying it to each instalment (and redemptions, if any) would give you the current value of the total investment. In mathematical terms, XIRR is known as a single rate of return.
In other words, you can utilise this mathematical concept to calculate consolidated returns when you purchase or redeem units in a fund at irregular intervals. Precisely, XIRR is your actual return on investments.
To understand the relevance of using XIRR for calculating mutual fund returns, we’ll take a look at this example:
Suppose Rohan invests Rs. 5,000 in a mutual fund scheme via SIP. He continued to allocate his savings to this fund for a period of 5 years. Now, let’s say that after the completion of 5 years, the total value of his investment stood at Rs. 5,50,000.
In this scenario, the first instalment of Rs. 5,000 has been invested in the scheme for the longest duration (5 years). As a result, the annual return on the first instalment amount will not be the same as the returns earned on the following investments made in the fund.
In simple terms, since the investment period for each instalment is different, the corresponding compounded annual growth rate (CAGR) differs. For investors, analysing the performance of the scheme considering the CAGR of each of these monthly investments can be quite challenging. To combat this issue, they can take all these CAGRs together and adjust them to a common rate. This adjusted CAGR refers to XIRR in mutual funds.
While CAGR (Compound Annual Growth Rate) is considered good for lump sum investments, XIRR or Extended Internal Rate of Return is good for SIP investments. For SIPs, every investment is considered a new investment and that’s because you have money invested for different time periods.
For instance, if you have a 5-year SIP, your first instalment will be considered for a period of 5 years, the second instalment will be considered for 4 years 11 months and so on. This means that each amount invested compounds for a different time.
XIRR takes this into account and calculates the CAGR of every SIP investment made. These are then added together to give you the overall CAGR. So, you can say that XIRR is somewhat related to CAGR.
Investors can compute XIRR conveniently using the inbuilt function in MS Excel, where the formula to calculate XIRR is “= XIRR (value, dates, guess)”.
Open the application on your device and follow these steps to calculate the yearly returns for multiple cash flows at irregular intervals:
To simplify your understanding further, let’s take a look at an example below.
Here is an example of a six-month SIP to calculate XIRR in mutual funds.
Let’s assume cash flows as mentioned in the table below:
Let’s take a look at the calculation part below.
You will have your XIRR value of 11.92 %, as mentioned in the table.
It’s difficult to determine what one would call a good XIRR, but usually, an XIRR of 12% on an equity mutual fund for an investment period of 10 years could be good enough. Similarly, XIRR above 8% should be decent enough for debt mutual funds.
However, note that the rate of returns depends on various factors, including investment duration, risk-factor and inflation to name a few.
Keep these points in mind when calculating XIRR in mutual funds:
In case you’ve switched to a different mutual fund scheme, treat the transaction as an inflow or outflow based on whether you’re calculating XIRR for the target fund or the source fund. Note that this is relevant only when you’re computing XIRR at a scheme level. If you’re computing XIRR of your mutual fund portfolio, which includes all the schemes that you’ve invested in, this point is irrelevant.
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Here is a tabular representation of the differences between CAGR and XIRR:
|Basis of Difference||XIRR||CAGR|
|Meaning||It refers to the average rate of return earned on every investment made in a fund during a specific period.||It refers to an investment’s annual rate of growth over a particular time period (more than one year).|
|Consideration of multiple cash flows||Calculation of XIRR in mutual funds involves the consideration of multiple cash flows.||CAGR calculation does not take into account multiple investments made in the scheme during a specific timeframe.|
|Investment timing||Timing of the investments/ cash flows is essential as it has a direct impact on the returns. In other words, investors’ gains could be higher or lower||Since CACG considers only one cash flow, the period between the date on which the investment was made and the redemption date is what matters. Note that the CAGR of a scheme is directly proportional to the duration for which investors hold their units.|
|Type of measure||Annualised||Absolute return|
|Ideal for||This metric accurately measures the performance of SIP as well as lump sum investments.||CAGR measures the performance of lump sum investments only as it does not consider multiple cash flows.|
XIRR is the most comprehensive way of determining your returns in case of multiple transactions, especially when your investment time is irregular.
In other words, allocating your money to mutual funds via an SIP will lead to cash outflows and cash inflows. In such cases, the time of investment also plays a significant role in the calculation of the returns. To that end, the role of Extended Internal Rate of Return (XIRR) in SIP becomes essential.
Ans: IRR is used to determine returns against investments made at fixed intervals. But investments and redemptions are never regular. In that case, XIRR is the right choice.
Ans: A SIP or Systematic Invest Plan is a tool to invest in mutual funds. It is a systematic way to invest a fixed sum of money in a periodical manner. It is also a very safe way to invest.
Ans: Return on Investments for National Pension Scheme gives the annualised effective compounded return rate in the PRAN account and is calculated using the formula of XIRR. The calculation is done considering all the contribution/redemptions processed in the PRAN account since inception and the latest valuation of the investments.
Ans: XIRR Return is the returns on your mutual fund investments made at irregular intervals, like SIP investments. XIRR calculates the CAGR of every SIP investment made. These are then added together to give you the overall CAGR.
Ans: CAGR gives you the value of your annual return over a period of time longer than one year. But in the case of calculating returns on frequent investments or cash flows during different time periods, such a method is not apt as it does not consider multiple cash flows. In such cases, XIRR is an ideal option.
Ans: The XIRR function in MS Excel always computes an annualised IRR even if an individual calculates returns on weekly/monthly cash flows.
Before you go…
Disclaimer- Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.