XIRR in Mutual Funds : A Complete Guide

Mutual funds are a popular investment choice in India, offering a diversified portfolio and professional management. But accurately assessing your returns can be tricky, especially with Systematic Investment Plans (SIPs) or multiple transactions. This is where XIRR (Extended Internal Rate of Return) comes in.

Dive deeper into this blog to understand how XIRR in Mutual Funds can offer a clearer picture of your investment journey and empower you to make informed financial decisions.

What is XIRR in Mutual Funds?

XIRR, or Extended Internal Rate of Return, is a financial metric used to calculate the annualized return on your mutual fund investments that involve cash flows at irregular intervals.
Unlike simpler methods like CAGR (Compound Annual Growth Rate) that assume consistent investment periods, XIRR incorporates the timing and amount of each investment you make and any redemptions you might have along the way. This is particularly useful for scenarios such as SIPs and multiple investments and redemptions.

How is XIRR Different from CAGR?

CAGR and XIRR are both financial metrics used to evaluate investment performance. However, they differ in their approach, making them suitable for different scenarios. Here is a comparison between XIRR and CAGR.
 

Parameter	XIRR	CAGR
Focus	Time-weighted return based on cash flow timing and amount	Smoothed average growth rate over the entire investment period
Suitability	Investments with irregular cash flows (SIPs, multiple investments/redemptions)	Lumpsum investments
Accuracy	More accurate for irregular cash flows	May overestimate/underestimate for investments with irregular cash flows

Can We Use CAGR Instead for Calculating Returns?

While the CAGR is a frugal financial metric for evaluating investment performance, it’s not an ideal approach when cash flows are irregular, especially in the case where SIPs are involved.
Here's why using CAGR instead of XIRR might not be the best approach:

•    Inaccuracy: CAGR assumes a constant growth rate throughout the investment period. This could lead to overestimating returns if your investments grew rapidly at the beginning and then went flat, or underestimating returns if they grew slowly initially and then accelerated.

•    Ignores Timing: CAGR doesn't consider when you invested money. With SIPs or multiple deposits, the timing of your contributions impacts your overall returns. XIRR takes this into account by factoring in the time value of money.

•    Limited Visibility: CAGR provides a single, smoothed-out growth rate. This can mask the actual volatility and performance fluctuations within your investment.

How is XIRR Calculated?

Now that we understand how XIRR provides a holistic method to calculate returns on your investment, let’s learn how it is calculated. While there isn’t a straightforward method to calculate the returns based on XIRR, you can use a spreadsheet such as Microsoft Excel that has a built-in XIRR to calculate the returns.

Excel formula for XIRR is =XIRR (value, dates, guess)


Here are the steps to calculate XIRR in Excel:
1.    Dates matter:
In Column 1, record the date for each transaction.

2.    Track your transactions:
In Column 2, list all your investment activity (inflows and outflows).
Mark outflows (acquisitions, investments) as negative numbers.
Mark inflows (redemptions) as positive numbers.

3.    Current value:
In the last row, enter the current value of your holdings and its redemption date.

4.    Calculate your return:
Below the redemption value, type the formula =XIRR (values, dates) in Excel.
This formula considers the timing of your transactions to give a more accurate picture of your return.
Press Enter to get the XIRR.

5.    Percentage return:
Multiply the XIRR by 100 to express it as a percentage.

Example of XIRR Calculation in Excel

Here’s how the XIRR for 6 month-SIP in mutual funds is calculated:

•    SIP Amount: Rs. 10,000
•    SIP Investment Period: 1-April-24 to 9-September-24
•    Redemption Date: 10-October-24
•    Maturity Amount: Rs. 64,000

Date	Investment Amount
4/1/2024	-10,000
5/3/2024	-10,000
6/5/2024	-10,000
7/7/2024	-10,000
8/8/2024	-10,000
9/9/2024	-10,000
10/10/2024	64,000
XIRR Formula	=XIRR(values,dates)*100 and press enter

Based on the above calculation of XIRR in Excel, the XIRR, as per this example, is 23.36%.

Utilizing XIRR to Analyze Your Mutual Fund Investment Performance

While CAGR is a valuable tool for analyzing potential returns on mutual funds, it assumes a steady investment. For a more accurate picture of your actual returns, especially with investments involving multiple deposits at different times, XIRR is the better metric to use.
 

Importance of XIRR in Mutual Funds

XIRR is crucial for mutual fund investors making multiple transactions. Unlike basic methods, XIRR considers the timing and amount of each investment and withdrawal, giving a more accurate picture of your actual returns. This is especially important for SIPs and withdrawals.

XIRR reflects your personal investment strategy, providing a more personalized return compared to advertised rates. It allows for fairer comparisons between your investment's performance and benchmarks. In short, XIRR helps you understand the true profitability of your mutual fund considering your own investment choices.

Conclusion

XIRR goes beyond basic return calculations, considering the time value of money and irregular cash flows. By understanding XIRR, you can gain a clearer picture of your mutual fund's performance and make informed investment decisions. 
 

FAQs

Here are the answers to some of the commonly asked questions about XIRR in mutual funds.
  Generally, a XIRR of 12% is considered good for equity mutual funds, while 7.5% is considered good for debt funds.
  You likely won't find the XIRR readily available from your mutual fund provider. However, you can calculate it yourself using the information in your account statements (investment amounts and dates) and the XIRR function in Excel.
  While XIRR is a valuable tool, it's important to understand its limitations. XIRR assumes all cash flows are reinvested and doesn't account for taxes or fees you might incur. Also, it doesn't provide information about the risk involved in the investment.
  XIRR is best suited for calculating the return on a single investment with irregular cash flows. If you have multiple SIPs in different funds, it's recommended to calculate the XIRR for each SIP separately. This will give you a clearer picture of the performance of each individual investment.
  Yes, XIRR considers all cash flows associated with your mutual fund investment. This includes dividends that are automatically reinvested, as these represent additional purchases of units in the fund. The cash flow amount for reinvested dividends would be positive and the date would be the reinvestment date.