What Is XIRR? XIRR vs IRR vs CAGR
While investing in mutual funds and other investment plans, it is necessary to calculate and monitor the returns from such investments regularly. Many investment tracking platforms are available online where you can track the performance of your investments. On such platforms, you can use various mathematical functions like CAGR, XIRR and IRR, to decide whether a particular investment is worthy of your portfolio in the long run or not.
But, what is XIRR and how is it different from the other three functions?
This blog offers a closer look at XIRR, IRR and CAGR and lists their usage and differences.
What Is XIRR?
XIRR is the abbreviation for Extended Internal Rate of Return. It is a Microsoft Excel function which helps to calculate annualised returns on investment which involves irregular transactions.
XIRR is a single rate of interest that you can apply to all your investments to compare their rate of returns. This is your actual rate of return or personal rate of investment for calculating returns against multiple transactions including SIP investments.
It is a modification of IRR, a metric used to measure the returns of cash flows (inflows or outflows) in a series. XIRR allows you to measure individual cash flows on different dates, making it a very accurate method of calculating returns.
Calculation for XIRR
To calculate XIRR you can use the CAGR formula for your lump sum investments. However, this formula will not provide proper results if you are investing through Systematic Investment Plan (SIP) and withdrawing amounts through Systematic Withdrawal Plan (SWP).
Evaluating XIRR through a manual calculation for multiple irregular transactions can get complicated and time-consuming. To avoid inaccurate results, you can opt for the XIRR function in Microsoft Excel.
This function allows quick calculation of non-periodic cash flows. It also helps to understand the rate of return that an individual earns on his/her investment. By calculating XIRR with Excel, you can decide between two or more investment plans quickly.
The formula to calculate the Extended Internal Rate of Returns is given below.
XIRR (Values, Date, [guess])
In this formula:
- ‘Values’ = An array of cash flows during a stipulated interval.
- Dates = These are a series of dates that corresponds to values. They demonstrate the times a certain cash flow occurred. The first date is the starting point, and the rest follows as later days of transactions.
- [guess] = This is an estimate of what the IRR will be. If you do not enter a [guess] value manually, the system will assume it as 0.1.
What Do You Mean by IRR?
Internal Rate of Return (IRR) is an annual rate of growth that you can expect your investment to generate. As mentioned, it allows you to calculate the exact rate of returns of an investment plan based on cash flows. This can include periodic and systematic investments you have made as well as lump sum amounts.
This is evaluated in the same way as you calculate the Net Present Value (NPV). In this, cash flows (both inflows and outflows) get discounted based on when it happens. If the cash flows happen earlier in the investment period, it is discounted less and vice versa. This is due to the fact that the value of cash diminishes over time.
IRR helps companies to analyse and understand the capital budgets of projects and compare their potential returns.
Individuals can also use IRR to evaluate insurance policies, their premiums and other benefits. This assists to make major financial decisions like choosing life insurance. It is a common belief that insurances with a high IRR are a better option.
How to Calculate IRR?
To calculate IRR we follow the mathematical formula given below.
0 = NPV=t=1tct(1+IRR)t -c0
- ct= Net inflow of cash during the given period t
- IRR= Internal Rate of Interest
- c0= costs of initial investment
- t= number of times
When using this formula, you must set NPV to 0 and calculate the IRR which is the discount rate. This will provide you with the discount potential cash flow from a project.
You can calculate the IRR manually using this formula above. However, owing to its complex calculation process, there are chances of inaccurate results with manual calculations. To avoid such a scenario, you may opt for IRR calculating software available online or use MS Excel for accurate results.
So, what do these calculations indicate?
As stated earlier, IRR helps companies to understand the worth of a project by calculating their future gains. Therefore, if the IRR value is high, it means that the project is good for that company. On the other hand, a low IRR predicts that the project might bring minimal or slow growth.
Also, IRR helps to understand the estimated value of a project based on potential gains and expenditures.
What Is CAGR?
Compound Annual Growth Rate (CAGR) calculates your total earnings on all your investments during a year at a specific interval. This is the average rate at which your investment grows in value in a year. Parameters like the company’s performance over a given period, earnings, sales, and revenue are a few of the factors that help determine a company’s CAGR.
CAGR provides a better understanding of returns compared to absolute years. It tells you how much your investment has grown on an annual basis regardless of its yearly returns. It is also called annualised returns and is one of the most common metrics used to measure mutual fund performance.
As investments do not grow uniformly every year, CAGR offers a fund’s average earnings during a stipulated period. CAGR serves only representational purposes to demonstrate how much your investments have grown at the same rate every year.
What Is the Formula of CAGR and Its Calculation?
You can calculate the CAGR of your investments using the formula below.
CAGR= (End value/ beginning value) ^1/n -1)
Here, n is the investment period.
Let’s understand this calculation using a simple example. For instance, Aneesa invests ₹1,000 in XYZ fund for 3 years. Although her NAV was the same for the 1st year, it changed to ₹1,100 in the second year. As the NAV matured in the third year, the value became ₹1,300.
So what will be CAGR growth as per the formula above?
CAGR = (1,300/1,000) ^1/3 -1
= 0.0913, which is 9.13%
This highlights that the NAV of XYZ fund rose at a CAGR of 9.13%
You can calculate CAGR using this formula manually. However, manual calculations might not provide accurate results and can also seem time-consuming. Therefore you can use online calculators or software like MS Excel to calculate CAGR instantly.
What Are the Differences between XIRR, IRR and CAGR?
The table below compares the differences between XIRR, IRR and CAGR:
|XIRR is used to calculate the average cash flow for multiple and irregular transactions in a given period.||Helps calculate ROI for multiple investments.||Calculates the average annual returns of mutual funds for a given period.|
|Focuses on transactions that involve SIP.||Majorly focuses on lump sum and SIP investments done periodically.||Concentrates on the start and end values of investments for a certain time.|
|You can calculate XIRR with 3 parameters- values, guess and date||It uses only 2 parameters Values, and guess||Uses end value, beginning value and investment period to evaluate CAGR|
|Helpful to calculate cash flows at different intervals of time||Investors use this to analyse future investment outcome||It can be used for investments where only the beginning and ending values are important.|
|You cannot use XIRR for short tenure like 1 year||It does not consider any period.||CAGR ignores time value of money.|
|Formula= ∑of all instalments||Formula= 0=NPV=t=1tct(1+IRR)t -c0||Formula = (End value/ beginning value) ^1/3 -1)|
This blog has explained XIRR, IRR and CAGR and the differences between them. As a complicated concept, you may find calculating these manually can be time-consuming. Therefore, consider using the built-in formulas from Microsoft Excel and online returns calculators to easily calculate these values. Using CAGR, IRR and XIRR, you can accurately compare the performance of your investments.
Frequently Asked Questions
What are the advantages of CAGR?
CAGR is easy to calculate and understand. It can be used to compare different investments for a given period. It also offers a uniform rate of return and you can use CAGR to assess business products, divisions and segments’ performances.
What are the disadvantages of IRR?
IRR assumes that all cash flows occur at the same interest rates and does not consider the investment period. The same calculation can provide multiple IRRs for the same investments. For IRR, you also need to assume a constant rate of return throughout the investment period which is practically not feasible.
What is Net Present Value (NPV)?
Net Present Value (NPV) is the difference between the values of current and future cash flows. It is used to determine if the financial gains from a certain project will be more than today’s investment. The formula to calculate NPV is (Cash flow/ Discount rate or IRR)/ 1^n.