XIRR In Mutual Funds, Importance & Return Calculation

Mutual funds

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 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). 

What is XIRR in Mutual Funds?

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 different points in time. 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.

Relevance of XIRR in Mutual Funds

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.

Also Read: CAGR calculator: How to calculate compound annual growth rate

What is XIRR in SIP?

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. 

How To Calculate XIRR In Excel?

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: 

• First, type all your transactions in a single column. 
• Mark all cash outflows like purchases and investments as negative, while all inflows like redemptions will get marked as positive.
• Besides this column, create another one to add the corresponding transaction dates.
• Now, in the last row, type your holding’s current value of your holdings and the current date.
• It is time to use the XIRR formula in excel now. Please refer to the formula mentioned above.
• Now, you will have to choose values for a cash flow series that corresponds to the scheduled payment dates. The date column represents the date on which you first made an investment and the time of receiving cash flows.
• The Guess parameter is optional. In case you do not enter a value in excel, use a value of 0.1.

To simplify your understanding further, let’s take a look at an example below.

Example of XIRR Calculation

Here is an example of a six-month SIP to calculate XIRR in mutual funds:

• SIP amount = Rs. 5,000
• SIP investment dates: Start on 01-01-2017, End on 01-06-2017
• Date of redemption: 01-07-2017
• Maturity sum = Rs. 31,000

Let’s assume cash flows as mentioned in the table below:

Let’s take a look at the calculation part below:

• In the left column, all the dates are mentioned. 
• The right column includes your SIP instalments of Rs. 5,000. It is marked as negative owing to the outflow of cash.
• In the left column, you can find the redemption date. Just beside that, there is the redemption amount of Rs. 31,000.
• Use the XIRR formula: Insert the range of cells that represent the transaction values. After that, enter the series of payment dates with respect to the value of the cash flows. 

You will have your XIRR value of 11.92 %, as mentioned in the table.

Also Read: Zero Brokerage Demat Account

What is a Good XIRR in Mutual Funds?

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.

Things to Remember When Computing XIRR

Keep these points in mind when calculating XIRR in mutual funds: 

• Mark all outflows (lump sum investments/SIP instalments as negative. 
• Enter positive values of all inflows (SWP/redemptions).
• In case you have not redeemed all your units in a fund, you need to enter the current value of the investment along with the NAV’s date when computing XIRR 
• Actual cash flow doesn’t take place in the case of reinvestment of dividends or similar transactions. Hence, you must exclude these during the XIRR calculation. 

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.  

Also Read: Overnight Mutual Funds

Differences between CAGR and XIRR

Here is a tabular representation of the differences between CAGR and XIRR:

Final Words

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.

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FAQs on XIRR in Mutual Funds

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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.

This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.