One invests in a mutual fund scheme over a period to achieve their financial or investment objectives. They earn returns from their mutual fund investments in the form of capital appreciation. So how does one know what would be their return after a certain duration? It can be found using two methods – CAGR (compounded annual growth rate) and XIRR. XIRR is used in a scheme if there are multiple inflows and outflows.
In this article, you will learn what XIRR is and how you can calculate mutual fund returns using it!
What is XIRR?
XIRR is a rate of return that you can apply at multiple installments of investment or frequent withdrawals to find out the current NAV of your holdings. The full form of XIRR is – Extended internal rate of return.
The extended rate of internal returns is referred to as a single rate of return. Whenever there are multiple investments, withdrawals, or transactions from a mutual fund scheme, it becomes challenging to find the actual value of the investment using CAGR. This is where XIRR comes into the picture and provides the actual return that one may get on their investments.
XIRR is useful in the case of investments via SIP when there is a regular inflow of some amount in a mutual fund scheme.
Why do we use XIRR in mutual funds investments?
XIRR is most useful when there are inflows or outflows from a mutual fund scheme at irregular time intervals. If investments and redemptions do not exist over the entire tenure, then one can use the CAGR technique to find actual returns. However, mutual fund investments do not work like that, especially investments made through SIP.
Suppose you invest in a mutual fund scheme using the SIP method, and you invest an amount of Rs. 5,000 over seven years. At the end of 7 years, you decide to redeem your investments, whose total value is Rs. 7,00,000. Now, in this investment, there would have been cash inflow (investment) or cash outflow (redemption) at different periods. The timing plays an essential part in determining the investment return. To know the return value, you must use XIRR, which takes care of multiple cash flows.
XIRR becomes important as returns are received on the Rs. 5,000 invested in the first month will be higher than subsequent payments. It becomes difficult for people involved in analyzing these funds’ performance to find the returns using compounded annual growth rate formula. Hence, all monthly CAGRs are cumulatively taken together and adjusted to a particular rate. This adjusted rate of CAGR is XIRR. It gives a consolidated return figure after taking into account multiple transactions.
Importance of XIRR in Mutual Funds
XIRR is an important component of mutual funds structure allowing fund managers to have a detailed analysis of the fund’s performance. Individuals can use XIRR formula in an Excel sheet to determine the actual return on investment. This formula is a more accurate measure than IRR as it considers cash flows at irregular intervals. IRR or internal return rate considers that all transactions (inflow and outflow) occur at regular time intervals, which is not the case in reality. Hence, XIRR is an upgrade over IRR.
One needs to put the particular transactions, like SIP instalments and redemptions, along with the corresponding dates to the formula in Excel sheet to find out the returns earned.
How to calculate XIRR in excel?
You can easily calculate the extended internal rate of return using Microsoft Excel. The formula for XIRR calculation in Excel is = XIRR (value, date, guess), where value is the transaction amount, i.e., investment or redemption. Date is the corresponding date on which the transaction takes place.
You must follow these steps after opening Microsoft Excel on their devices:
- First, you need to enter all transactions that took place in a single column.
- All cash outflows like regular payments for investment must be marked negative, and cash inflows like redemption amounts must be positive.
- You must type transaction dates in the next column. These dates must correspond to transactions occurring.
- In the last row, you must fill in the present value of the investment and the corresponding date of this value.
- After this, you must use the XIRR formula to calculate the actual return rate.
- The next step involves selecting values for the cash series corresponding to payment dates. The date column includes the date on which the first investment was made and when cash flows were received. The IRR rate ‘guess’ in the formula is not mandatory. If you do not fill any value, Excel takes 0.1 as the default value.
Here’s an example of XIRR calculation using Excel:
SIP amount is Rs. 2,000. The period of investment is six months (01.01.2020 to 01.06.2020). The maturity date is 01.07.2020.
The cash flows are as follows:
| 01.01.2020 | -2,000 |
| 01.02.2020 | -2,000 |
| 01.03.2020 | -2,000 |
| 01.04.2020 | -2,000 |
| 01.05.2020 | -2,000 |
| 01.06.2020 | -2,000 |
| 01.07.2020 | 12,500 |
| XIRR | 14.91 |
In this example, we have taken dates in one column and SIP payments (in negative) in the next column. In the second last row, we have filled the maturity dates and amount, respectively. We used XIRR formula in the last column, inserted a series of cells exhibiting the cash flow values, and filled in the payment date series regarding transaction values.
After using the formula =XIRR (values, dates, guess), we got the XIRR as 14.91%.
Final Word
XIRR is an efficient technique that allows one to calculate the actual return rate in a mutual fund scheme with multiple cash flows. It is more reliable and accurate than CAGR as it considers transactions spread over a period. This detailed guide on XIRR, its importance, and how to calculate it will help investors gain insightful knowledge about it.
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Frequently Asked Questions
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What is considered a good XIRR?
A good XIRR is a subjective figure and differs from individual to individual. However, experts have pointed out that an XIRR of 11-12% is considered good in the case of equity funds and 7-8% in the case of debt mutual funds.
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What is the return calculation of XIRR?
XIRR measures return in annualized form. It can be used for investments made in regular and irregular time intervals.
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What is CAGR?
CAGR is the annual rate of return of an investment compounded over a period. It uses the compounding process to arrive at the final return value. CAGR helps find returns made through a lump sum investment and not so much through SIPs.
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