The essential purpose of every investment is to maximize returns. Returns may consist of income, capital appreciation, or both. The two most common measurements of mutual fund returns are compound annual growth rate (CAGR) and XIRR (XIRR full form is Extended Internal Rate of Return).
As its name implies, the compound annual growth rate (CAGR) is the pace at which your investment increases annually during the investment term, assuming it gets yearly compounding.
While XIRR can be utilized in the case of mutual funds when there are numerous cash flows, CAGR is not relevant or cannot be employed when there are multiple cash flows. Therefore, calculating returns on investments if there are several transactions at various periods is the XIRR mutual fund definition.
What exactly is XIRR?
An indication of returns known as the extended internal rate of return, or XIRR, is used when several investments in financial instruments such as mutual funds take place on different dates. The current rate of return is determined by applying a single rate of return to all transactions (investments and redemptions). The only program that can calculate it is Excel.
The XIRR formula is an excellent tool for estimating returns. For example, a SIP consists of a succession of investments. Some of which may be redeemed partially and others can be missed altogether due to the opportunity to suspend SIPs. In this scenario, calculating the returns becomes simple using the XIRR calculator for SIP.
Why are mutual funds using XIRR?
Investment capital flows, whether coming in or going out, are never distributed equally. There are sometimes late deposits and early withdrawals. When many months are missed in a sequence, estimating the return on investment becomes difficult. When computing returns, time and investment quantity have distinct effects on the outcome.
Similar to SIP, lump sum, withdrawals via Systematic Withdrawal Plan (SWP), or lump sum investments in mutual funds, XIRR will assist in computing the returns after considering any anomalies.
How to calculate XIRR in Excel step-by-step?
To calculate what is XIRR in mutual fund, use Microsoft Excel. Excel’s most powerful method for calculating the annualized yield for a schedule of cash flows that happen at irregular intervals is the XIRR function.
All outflow cashflow like investments and purchases will be recorded in a single column and indicated in negative values.
The amount or value of the transaction should then be entered in the relevant column.
In the last column, enter the values and the dates that go with those values.
Finally, use the MS Excel XIRR function: = XIRR (values, date, Guess).
An Excel XIRR in mutual fund calculation example is:
SIP amount is Rs. 2,000. The investing term lasts for six months (01.01.2021 to 01.06.2021). The due date is July 1, 2021.
These are the cash flows:
01.01.2021 -2,000
01.02.2021 -2,000
01.03.2021 -2,000
01.04.2021 -2,000
01.05.2021 -2,000
01.06.2021 -2,000
01.07.2021 12,500
XIRR 14.91%
Dates are shown in one column in this example, followed by SIP payments (in the negative). The maturity date and amount are on the second-to-last row, respectively. The final column’s XIRR formula inserts a series of cells showing the cash flow values and fills in the payment date series for the transaction values.
To calculate XIRR in mutual fund schemes, all cash outflows (profit, SWP, dividends) get entered as positive values, and all funds (the regular SIPs) get recorded as values in the negatives (use a minus sign before the supplied amount). If you haven’t yet bought all your units, you’ll need to enter the current investment value to calculate the XIRR of your MF commitment. Some transactions, including reinvested dividends, should not be included in the XIRR calculation since they do not involve actual cash flows. Transitions provide a challenge; if calculating XIRR at the scheme level in a mutual fund, you should treat a changeover as a redemption.
The XIRR formula takes a variety of cash inflows and cash withdrawals into consideration. Using the formula XIRR return means, you can figure out the yearly average return of each payment. They are then changed to provide you with information on the average annual rate of return for all of your assets.
Isn’t it possible to utilize CAGR instead?
The most typical fallacy is the idea that CAGR and XIRR are interchangeable. However, both vary from one another in several ways. Typically, CAGR ignores the cash inflows and outflows over an investment period and estimates point-to-point returns alone. Conversely, every cash inflow and outflow get considered when XIRR calculates the return.
- The average rate of each cash flow earned is known as XIRR. CAGR, however, stands for compounded annual growth rate.
- XIRR, meaning in mutual fund, is about taking erratic cash flows into account. Conversely, CAGR considers the investment’s start, finish, and length of time. Point-to-point returns calculation happens using CAGR.
- The annualized return is determined using XIRR. In comparison, CAGR determines the return’s absolute and annualized value.
- When calculating the XIRR, several cash flows are taken into account. CAGR is in use to calculate returns on investments made using one-time payments.
XIRR and CAGR similarities and differences:
- XIRR and CAGR provide the same return for a lump sum amount invested only once yearly.
- XIRR and CAGR will provide the same yearly return throughout the course of the investment.
- Both XIRR meaning and CAGR will vary with many cash inflows and outflows.
- XIRR and CAGR fluctuate with changing returns, such as returns from mutual funds.
Key Takeaways:
Returns on mutual funds computation happen using the XIRR and the CAGR methods. CAGR is often used for payments made in a single instalment, but XIRR is more frequently utilized for contributions made under a systematic investment plan. Suppose you are the owner of any such investments. In that case, it is generally in your best interest to be conversant with the calculations of return so that you are not dependent on anybody else.