XIRR, or Extended Internal Rate of Return, is a financial metric used to calculate the annualized return on an investment that involves multiple cash flows occurring at irregular intervals. Unlike simple return calculations, XIRR considers the timing and amount of each cash flow, providing a more accurate representation of the investment's performance.
This makes XIRR particularly useful for investments like Systematic Investment Plans (SIPs) in mutual funds, where regular investments are made over extended periods. By understanding XIRR, investors can assess the true profitability of their investments and make informed decisions. In this article, we will delve deeper into the concept of XIRR, exploring its meaning, how it works, its benefits, the underlying formula, and practical steps to calculate it.
What is XIRR?
XIRR (Extended Internal Rate of Return) is a crucial tool for evaluating mutual fund returns, offering a precise measure of investment performance over time. By accounting for the timing and size of each cash flow, XIRR provides a more accurate reflection of an investor's financial experience.
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.
What is XIRR in mutual fund with example
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.
Points to be noted when calculating XIRR in Excel
To accurately calculate the XIRR (Extended Internal Rate of Return) of a mutual fund investment, it's essential to correctly input cash flows.
- Cash outflows: All monetary outlays, such as Systematic Investment Plan (SIP) instalments, lump sum purchases, and switch-outs, should be entered as negative values.
- Cash inflows: All monetary inflows, including Systematic Withdrawal Plans (SWP), dividends, redemptions, and switch-ins, should be entered as positive values.
- Current investment value: If units have not been fully redeemed, the current market value should be included along with the corresponding Net Asset Value (NAV) date to complete the XIRR calculation.
Note on transaction inclusion
- Transactions that do not involve actual cash flows, such as dividend reinvestments, should be excluded from the XIRR calculation.
- Switches:
- Scheme-level XIRR: A switch should be treated as a redemption (cash outflow) in the source scheme and an investment (cash inflow) in the target scheme.
- Portfolio-level XIRR: Switches are irrelevant to the overall portfolio-level XIRR calculation as they do not involve external cash flows.
By accurately inputting cash flows and considering these nuances, investors can obtain a precise measure of their mutual fund investment's performance.
XIRR in Account Statements (AS)
Mutual fund companies typically provide Account Statements (AS) to their investors, which include a comprehensive summary of their investments. This summary encompasses details such as the average investment cost per unit, total units held, total investment amount, current valuation, and annualized returns. These annualized returns are calculated using the widely-accepted XIRR method, which considers both Net Asset Value (NAV) appreciation and dividends received over the investment period.
The XIRR method offers a standardised approach to measuring investment performance, making it a valuable tool for investors to compare the returns of different mutual fund schemes. By analyzing the XIRR values, investors can assess the relative performance of their investments, considering factors such as the investment duration and market conditions. This informed comparison empowers investors to make strategic decisions regarding their investment portfolio.
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.
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.
What is XIRR in SIP?
XIRR (Extended Internal Rate of Return) is a method used to calculate annualised returns for investments with irregular cash flows. In a Systematic Investment Plan (SIP), where investments are made regularly over time, cash flows may sometimes be uneven in timing or amount.
XIRR accounts for these variations by considering the exact dates and amounts of all transactions, providing an accurate representation of your returns. Unlike simple return calculations, which can be misleading for irregular cash flows, XIRR offers a more precise measure of performance.
For SIP investors, XIRR is an invaluable tool. It helps assess the actual performance of investments, enabling you to move beyond approximate methods that may not fully reflect reality. This makes it particularly useful when comparing different investment options.
Whether you are investing in mutual funds or stocks through SIPs, XIRR provides a clear view of your annualised returns. It empowers you to make informed decisions, plan effectively, and optimise your investment strategy for better financial outcomes.
Importance of XIRR in SIP
XIRR is an essential metric for evaluating the performance of Systematic Investment Plans (SIPs). It provides a precise calculation of returns by factoring in the exact dates and amounts of all cash flows, offering a true reflection of your investment's growth.
This accuracy is particularly important for SIPs, as they involve periodic investments that may vary in amount and frequency. Traditional return calculations often overlook these nuances, whereas XIRR accounts for them, ensuring a clear understanding of your investment performance.
By using XIRR, you can effectively compare returns across multiple SIPs or different financial instruments. This enables you to identify which investments are delivering the best results, aiding in better decision-making.
Additionally, XIRR is a valuable tool for financial planning. It helps you set achievable goals, track your progress, and make necessary adjustments to improve outcomes. Knowing your exact rate of return keeps you motivated to stay committed to your SIP strategy.
In summary, XIRR simplifies the management of SIP investments, ensuring you maximise your returns and make the most of your financial efforts.
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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.
