XIRR in Mutual Funds - Meaning, Calculation, Example, Difference with CAGR

XIRR in Mutual Funds

Almost all the investors would have once heard the term XIRR and many of them didn’t know the exact meaning and the use of it. In this article, we will understand what is XIRR and how does it work?

What is XIRR?

XIRR or the extended internal rate of return is a tool for measuring the returns. It is mostly used to calculate the return where cash flows are done between the investment periods. Like, we do in the case of SIPs or systematic investment plans in mutual funds. A SIP is a method of investment wherein investments are made regularly after pre-specified intervals. XIRR can also be used to calculate the returns for the lumpsum investment, but for lumpsum investment, the most used and best tool to calculate the returns is CAGR i.e. compounded annual growth rate.

In other words, we can say XIRR is one of the best tools to calculate the returns of irregular cash flows.

Now the question will come in what are irregular cash flows.

What are Irregular Cash Flows?

Irregular cash flows are also known as multiple cash flows or uneven cash flows. Irregular cash flows in the case of mutual funds can be like SIP investment every month, additional purchases, partial redemption, and other cash flows.

XIRR in mutual funds

XIRR is used in mutual funds to calculate the returns when there are irregular cash flows done by the investor. In this case, the internal rate of return will also lead to an inappropriate answer, that’s why the extended internal rate of return is used. XIRR comes out with an appropriate and right outcome for the irregular cash flow or investment and redemptions.

Difference between CAGR and XIRR

CAGR and XIRR are almost the same return metric as both are used to calculate the returns from an investment.

• CAGR is most widely used to calculate the returns of lumpsum investments while XIRR is used in the case of irregular investment like in SIPs.
• CAGR shows the annual growth rate of an investment during a period and XIRR also shows the same thing. It also shows an annual growth rate of an investment over a period of time.
• CAGR mostly has one investment to calculate the annual growth rate while XIRR uses the irregular cash flows to calculate the annual growth rate.
• CAGR simply calculates the growth rate while XIRR treats every cash flow separately and calculates the CAGR for every investment and then adds it for the final result or growth rate.

How does XIRR work?

XIRR treats every investment separately and then calculates the CAGR for every investment individually with their respected invested period. After that, it adds the CAGR for every individual investment and comes with the result.

Let us understand it with a simple example:

There is a very long and complicated formula to calculate XIRR using a calculator. To calculate the XIRR, the best and simplest way to do it is using Microsoft excel.

In excel, one needs to put all the cash flows during a period along with the date of the cash flow. And, then can use the formula i.e. “=XIRR”. After using the formula, select all the values first and then the dates.

After doing so, excel will return with the result.

Like we did, we assumed a  simple situation to calculate it. An investor starts a SIP of Rs.10,000 every month and continues it for 5 years. Suppose he/she started a SIP on 1st January 2016 and continued till 1st December 2020. And redeemed all the units on 31st December 2020, and did not redeem any unit in between. One more thing to keep in mind, when the values will be entered in excel, do not forget to enter the outflow values in negative.

The total investment done will be Rs.6,00,000. Now, let us assume that on 31st December 2020, the value of the investment or redemption value is Rs.8,00,000. 

Now, using excel, the XIRR which comes out is 11.44%. It means an investor would have generated 11.44% annually on his investment.

But, if in the same case we calculate the CAGR, then it will come to 5.92%, which is not appropriate. As it assumes that Rs.6,00,000 investment was done at the beginning of the period i.e. on 1st January 2016 and no investment was done after that.

So, here we can conclude that the best and appropriate measure to calculate the growth rate of irregular investments like SIP is XIRR.

Frequently asked questions

• What is XIRR?

XIRR or Extended internal rate of return is a return metric that is used to calculate the annual growth rate of investment. It is best used in the case of irregular investments like in SIP.

• How XIRR is better than CAGR?

XIRR is also the same as CAGR. The only difference is CAGR treats every investment together and then calculates the rate while XIRR treats every investment individually, then calculates the CAGR separately, and then adds it for the final result. This is the reason, CAGR is used where there are no cash flows between the periods while XIRR is used where there are cash flows in between the periods.

• How to calculate XIRR?

To calculate the XIRR using a calculator, there is a very long and complicated formula. But, it can be calculated by using Microsoft Excel in just a few steps. The formula to calculate using excel is “=XIRR”. In excel, one needs to enter all the cash flows along with the date and used the mentioned formula i.e. “=XIRR”.

• How does XIRR work?

XIRR treats every investment individually and separately calculates the CAGR for every investment. After this, it adds the CAGR of every investment and comes out with the result.

• How XIRR is used in mutual funds?

Every investor invests for returns. XIRR is just a method to calculate the return on SIP investments. It shows the annual growth rate of an investment or on how much annual rate an investor has generated returns.

• How XIRR is used in SIP investments?

XIRR is mostly used where there are irregular cash flows or multiple cash flows like there are in SIPs. In SIPs, an investor does multiple cash flows by an investment after regular or irregular intervals. XIRR treats every SIP installment individually and calculates the annual growth rate and then adds it for the final result.

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