XIRR, also known as the Extended Internal Rate of Return, is a metric used to calculate the return on investment for mutual fund investments. It is a mathematical formula used to measure the annualised return on investments that involve investments made and returns received at multiple time intervals. XIRR in mutual funds is a useful tool for investors to evaluate the performance of their investments. It takes into consideration the multiple investments and withdrawals made by the investor at different time intervals. In simple terms, XIRR is a method that calculates the returns on investments that happen at different points in time.
What is XIRR in Mutual Funds?
XIRR considers various cash inflows and outflows in its formula. It calculates the annual average return for each installment and adjusts them to provide an overall average annual rate of return for all your investments.
This calculation is especially useful for estimating the return on your systematic investment plan (SIP), where you regularly invest in a mutual fund scheme.
Additionally, if you opt for the Systematic Withdrawal Plan (SWP), you can utilise XIRR to gauge your overall return. SWP allows you to make regular withdrawals of a predetermined amount at fixed intervals. Using XIRR in this context helps in evaluating the effectiveness of your investment strategy and the returns generated over time.
Understand how XIRR is accurate with an example
Let us explore the accuracy of XIRR with an example. Imagine you initiated a monthly SIP of Rs. 8,000 in a mutual fund plan and maintained it for 4 years. Assume that after numerous fluctuations, your total investment swelled to Rs. 7.5 lakh at the end of the 4-year period.
In this scenario, your initial Rs. 8,000 contributions were invested for 4 years, totaling 48 months. The annual return for the first month's contribution will differ because it was invested for the longest duration. As each contribution remains invested for varying periods, their respective CAGR also fluctuates. Calculating the CAGR for each contribution of a mutual fund plan could be complex to analyse.
Hence, to simplify matters, all these CAGRs are amalgamated and adjusted to a common CAGR. This adjusted CAGR is depicted as the XIRR of a mutual fund plan.
The importance of XIRR in evaluating mutual fund returns
XIRR (Extended Internal Rate of Return) is crucial for evaluating mutual fund returns as it provides a precise measure of investment performance over time. Unlike simple annualised returns, XIRR accounts for the timing and amount of each cash flow, offering a more accurate reflection of an investor’s actual experience. This is particularly important for mutual funds where investments and withdrawals occur at various intervals.
By incorporating these irregular cash flows, XIRR presents a personalised rate of return, facilitating better comparison between different funds and investment periods. It enables investors to assess the true profitability of their investments, ensuring more informed and strategic financial decisions. Moreover, XIRR helps in aligning mutual fund performance with specific financial goals, offering a clearer picture of how effectively these goals are being met. Thus, XIRR is an indispensable tool for investors seeking a comprehensive and realistic evaluation of their mutual fund returns.
What is a good XIRR in mutual funds?
The good XIRR for mutual fund investments depends on several factors, such as investment goals, risk tolerance, and time horizon. A good XIRR for a mutual fund investment should be at least higher than the inflation rate. It is essential to check the XIRR of a mutual fund against its benchmark index and the average returns of similar mutual funds.
What is the XIRR formula?
The formula of XIRR is as follows:
XIRR = (NPV(Cash Flows, r) / Initial Investment) * 100
How to calculate XIRR in mutual funds?
You must enter the transactions (additional purchases, SIP/SWP instalments, redemption) and the related dates in the designated area of an MS Excel sheet in order to compute XIRR for mutual funds. The statement of account that the AMC (Asset Management Company) will send you will include information about these transactions.
You can use the following formula in MS Excel to determine a mutual fund's XIRR:
"=XIRR (values, dates, guess)"
Here, you must enter cash inflows (dividends, SWP, redemptions) as positive values and cash outflows (lump-sum purchases and SIP payments) as negative values (i.e., place a minus sign before the amount).
The entry "Guess" is optional. It is by default taken to be 0.1.
If you have not yet redeemed your mutual fund units, you must enter the current investment value along with the NAV (Net Asset Value) of your mutual fund investment to compute XIRR.
Transactions like dividend reinvestment should be excluded because they don't result in actual cash flows. Moreover, switches should be considered a form of redemption when determining the XIRR at the level of schemes. But switches are irrelevant in the computation if you are computing XIRR at the portfolio level for mutual funds.
Here’s the formula for calculating XIRR in excel:
XIRR formula in excel is: = XIRR (value, dates, guess)
Here's a breakdown of how to use it:
1. Prepare Your Data:
- Create a table with three columns:
- Date: Enter the dates (in year-month-day format) of your mutual fund transactions (purchases, redemptions, dividends).
- Cash flow: Indicate the amount of each transaction. Use positive values for investments (purchases) and negative values for withdrawals (redemptions, dividends).
- Units (Optional): If available, include a column for the number of units purchased/redeemed in each transaction. This can help visualize your investment activity.
2. Locate the XIRR Function:
- Navigate to the formula bar in your Excel spreadsheet.
- Click on the "Insert Function" button (usually denoted by Σfx).
- In the search bar, type "XIRR" and select the function from the list.
3. Enter the Function Arguments:
- The XIRR function requires two arguments:
- Values: This refers to the range of cash flow values in your table. Select the entire cash flow column (excluding headers).
- Dates: This refers to the range of dates corresponding to each cash flow. Select the entire date column (excluding headers).
4. Calculate the XIRR:
- Once you've entered the arguments, press Enter. Excel will calculate the XIRR and display the annualised rate of return for your investment.
Example: Calculating XIRR for a Mutual Fund Investment
Let's say you invested Rs. 10,000 in a mutual fund on January 1, 2023, and then made additional investments of Rs. 5,000 each on July 1, 2023 and January 1, 2024. You also received a dividend of Rs. 1,000 on July 1, 2024. Here's how to calculate the XIRR:
1. Prepare your data table:
Date |
Cash Flow (Rs.) |
Units (Optional) |
Jan 1, 2023 |
10,000 |
100 |
Jul 1, 2023 |
5,000 |
50 |
Jan 1, 2024 |
5,000 |
50 |
Jul 1, 2024 |
-1,000 (Dividend) |
- |
2. Locate the XIRR function and enter arguments:
=XIRR(B2:B5, A2:A5) (Replace B2:B5 and A2:A5 with your actual data ranges)
3. Calculate the XIRR:
Press Enter. Excel will display the XIRR value, which represents your annualized rate of return for this investment.
Step by Step process to calculate in Excel
The XIRR function in excel is a valuable tool for investors holding mutual funds with multiple transactions. It helps determine the internal rate of return (IRR) for these investments.
1. Enter transactions
- In Column A, enter the dates of all your transactions.
- In Column B, enter the corresponding cash flows. Outflows (like investments) should be marked as negative, while inflows (like redemptions) should be positive.
2. Add the current value
- In the last row, add the current value of your investment along with the current date. This will be treated as the redemption or inflow.
3. Use the XIRR function
- Now, use the XIRR function to calculate the returns. The formula is =XIRR (values, dates, [guess]).
- The “values” argument represents the series of cash flows (both positive and negative). The “dates” argument represents the corresponding dates for those cash flows. The “guess” is optional, and if omitted, Excel will use a default value of 0.1.
Example of how to use the XIRR function in excel:
Let’s calculate the return on a six-month SIP:
- SIP amount: Rs. 5,000
- Investment dates: Start - 01/01/2017, End - 01/06/2017
- Redemption date: 01/07/2017
- Maturity amount: Rs. 31,000
Cash Flow Table:
Date |
Cash flow |
01-01-2017 |
Rs. 5,000 |
03-02-2017 |
Rs. 5,000 |
01-03-2017 |
Rs. 5,000 |
11-04-2017 |
Rs. 5,000 |
01-05-2017 |
Rs. 5,000 |
25-06-2017 |
Rs. 5,000 |
01-07-2017 |
Rs. 31,000 |
Steps in Excel
1. Column A: Enter the transaction dates:
- A1: 01-01-2017, A2: 03-02-2017, A3: 01-03-2017, and so on until A7: 01-07-2017.
2. Column B: Enter the corresponding cash flows:
- B1: -5000, B2: -5000, B3: -5000, and so on until B7: 31000.
3. In the next empty cell, enter the formula: =XIRR(B1:B7, A1:A7)*100
4. Press Enter. The XIRR function will calculate the rate of return, and you will see a value of 11.92% displayed as the result.
What are the benefits of calculating XIRR in a mutual fund
Below are the key advantages of utilising XIRR in assessing mutual funds or ULIP funds:
- Precision: XIRR offers superior accuracy in gauging returns compared to CAGR by factoring in the timing of all cash flows. This proves crucial for both ULIP and mutual funds, where investments are often made periodically.
- Steadiness: XIRR provides consistent return measurements, even when cash flows are irregular, unlike CAGR, which may mislead with irregular cash flows.
- Adaptability: XIRR proves versatile in calculating returns for any investment, irrespective of cash flow patterns, making it an adaptable tool for evaluating investment performance.
- Clarity: XIRR ensures transparent return evaluations by relying on actual cash flows, facilitating easy comprehension of investment performance.
- Pertinence: XIRR holds relevance in assessing returns for ULIP funds and mutual funds by incorporating associated fees and expenses. Hence, it offers a more accurate estimation of anticipated returns.
For deeper insights, here are additional articles that are closely aligned with your interests
- Compounding in Mutual Funds
- Exit Load in Mutual Funds
- OTM in Mutual Funds
- Absolute Return in Mutual Funds
- Risks in Mutual Funds
What is the difference between XIRR and CAGR?
Here are some of the differences between the XIRR and CAGR:
|
CAGR |
XIRR |
Definition |
It is an absolute annualised return |
It is an average annualised return |
Calculation focus |
Initial value, investment tenure, and final value |
Every inflow and outflow of cash |
Suitability |
Ideal for lump-sum investments |
Ideal for investments like SIPs with multiple inflows and outflows |
Calculation method |
Compounded annual growth rate |
Average return generated by every cash flow throughout the investment tenure |
When evaluating investment returns, understanding the right metrics is crucial. Two commonly used methods are XIRR (Extended Internal Rate of Return) and CAGR (Compound Annual Growth Rate). While both aim to measure the performance of investments over time, they differ in approach and application. The above comparison table explores the key differences between XIRR and CAGR, helping investors determine which metric best suits their needs for calculating returns.
Limitations of XIRR?
Just as there are undeniable benefits, the XIRR return method also presents certain drawbacks.
Let us explore them:
- Dependence on accurate cash flow data: XIRR relies on precise and comprehensive cash flow data, encompassing both the date and amount of each cash flow. Inaccurate or incomplete data can compromise the accuracy of the XIRR calculation.
- Sensitivity to minor data alterations: XIRR is a highly sensitive metric, susceptible to even minor changes in the cash flow data. This sensitivity can pose challenges when comparing different investments or relying solely on XIRR returns for decision-making.
- Limited applicability to certain investment types: While ideal for investments featuring irregular cash flows, such as private equity or real estate investments, XIRR may not be suitable for those with regular cash flows, like bonds or annuities.
Could CAGR be preferable for determining returns?
When considering an investment in a mutual fund, we typically assess its performance over the past several years, such as three or five years. These performance figures represent compounded annual growth rates (CAGR), indicating the annualised growth of an investment over a specified period.
Evaluate whether past returns should influence your investment decisions.
This commonly used metric is employed to calculate investment returns across many mutual funds. While calculating CAGR for mutual funds is straightforward, it can be slightly more complex for personal investments.
Conclusion
As you can see from the examples above, XIRR is the best approach to calculating your real-world investment returns. CAGR is crucial to consider when choosing a mutual fund, but XIRR is critical when evaluating the returns on the investments you make. And IRR is employed for investments with equally spaced cash flows in time, but most investments are not as evenly spaced as you saw above in the case of mutual funds.
So, when a series of investments is made over time, involving transactions such as withdrawals, dividends, switching, and so on, XIRR is a superior approach to compute the return. XIRR is a far better tool for calculating mutual fund returns.
