Understanding XIRR: A right way to track Mutual Fund returns

Mutual funds have taken the investment world by storm, captivating seasoned investors and newcomers alike.

As of August 2024, the Indian mutual fund industry’s assets under management (AUM) have skyrocketed to an impressive INR 66.7 trillion, reflecting a vibrant market full of opportunities.

To truly utilise this investment avenue’s potential, it’s vital to understand the details of its returns. Key terms like XIRR (Extended Internal Rate of Return) and CAGR (Compound Annual Growth Rate) play crucial roles in this journey.

While CAGR offers a straightforward approach, many investors find themselves navigating the complexities of XIRR. This article will explore XIRR, providing the insights you need to boost investment strategies and make informed decisions.

What Is XIRR in Mutual Funds?

XIRR is an advanced Internal Rate of Return (a traditional alternative). It is a significant metric used in calculating returns on mutual fund investments where multiple transactions and irregular cash flow, including investments and withdrawals, occur at different times throughout the investment phase.

By the mathematical definition, XIRR, meaning in mutual fund, is a method to calculate the rate of return for investments. When applied to your instalments (and redemptions, if any), it gives you the actual rate of return based on cash flow timing. This reflects your total investment’s current value.

For example, consider an investor who makes several investments and withdrawals at different points throughout the year. XIRR calculates the rate of return, considering the timing and amount of each cash flow, offering a more accurate reflection of the investment’s performance than traditional methods.

Confusion About XIRR and CAGR

People often confuse XIRR with compound annual growth rate (CAGR). However, unlike XIRR, CAGR applies only to a single cash flow.

CAGR measures the returns of mutual funds in which a lump sum is invested, and the total investment is sold in a single redemption.

However, mutual fund investments through a systematic investment plan (SIP) or redeeming units with a systematic withdrawal plan (SWP) differ. CAGR is inadequate for accurate returns calculations, and XIRR is the appropriate method!

Importance of XIRR in Mutual Funds

Mutual fund investors may invest more or withdraw units irregularly throughout the investment phase. Simple, traditional methods can’t accurately calculate returns on irregular cash flow.

XIRR has proven to streamline calculations much better.

Here are the major significant advantages of XIRR:

Accurate investment performance assessment

The greatest importance of XIRR in mutual funds is the higher accuracy in returns calculation despite irregular and dynamic cash flow, including mutual fund SIPs.

It considers both the magnitude of cash flow and the time for which it was invested. This helps in evaluating the investment’s true performance.

Irregular Cash Flow Handling

Traditional methods like CAGR can’t handle irregular cash flow. On the other hand, XIRR accommodates multiple investments and redemptions of diverse contribution values and frequencies. Thus, inconsistent contributions make it more suitable for mutual fund SIPs.

Seamless Assessment of Diverse Portfolio

If you have diversified your portfolio with investments of different cash flow patterns, XIRR accurately evaluates the entire portfolio’s performance. This helps you understand the efficiency diversification and make necessary adjustments.

Time Value of Money Consideration

XIRR calculates returns by assessing the specific timing of your investments and withdrawals. This means it considers the value of money over time, providing a more accurate picture of your overall investment performance.

Investment Comparisons

XIRR also lets you compare investments with different cash flow patterns. For instance, you can compare SIPs with investments with varying contribution values or lump-sum investments.

Better Decision-Making

Since XIRR accurately calculates investment return, you can compare your investments and make well-informed decisions in asset allocation, financial goals, and investment strategies.

You can adjust investment decisions depending on financial goals and risk tolerance.

The Formula for XIRR in Mutual Funds

The most common method to calculate XIRR for mutual funds is to use the following XIRR formula in Excel or Google Sheets:

=XIRR(Values, Dates, [guess])*100

Here:

Values (cashflow_amounts in Google Sheets) = The total amount invested and redemption. All invested amounts are negative, and redemption amounts are positive.
Dates (cashflow_dates in Google Sheets) = The corresponding dates for each SIP instalment and redemption.
Guess (rate_guess in Google Sheets) = An initial estimate of the rate of return. You can leave it blank. Excel takes a default of 0.1, then.

How to Calculate XIRR in Mutual Funds?

Here are the steps to calculate the XIRR value properly in Excel or Google Sheets.

Step 1:Launch a fresh Excel or Google Sheets spreadsheet.
Step 2: Name the date column header as “SIP Transaction Dates” and the amount value header as “Cash Flow in INR.”
Step 3: Enter all the investments serially from the oldest to the newest. Put a negative sign before every SIP amount.

Remember, all SIP instalments (cash inflow) must be written with a negative (-) sign in front of them. Don’t add space between value and negative sign.

On the other hand, all redemption values (cash outflow) must be positive. You don’t need to add any positive (+) sign before it. Just write the number.

Step 4: Enter all corresponding dates against the cash flow values. Write the oldest date on the top and the newest on the bottom.

Note:Excel sheets and Google Sheets take dates in different formats, including DD/MM/YYYY and MM/DD/YYYY. Make sure the date format is correct.

Check this with these steps.

On Excel:

Click on the cell with the first date.
Click on Ctrl + 1.
If it’s not the format of your choice, choose accordingly.
Update all remaining date cells.

On Google Sheets:

Click on the cell of the first date.
Go to Format > Number > Custom date and time
Check whether it’s a favourable format. Otherwise, you can choose the date format or follow the default format.
Make sure all dates are in the appropriate format.

Step 5: Go to any blank cell where you want the XIRR value. Apply the XIRR formula “=XIRR(Values, Dates, [guess])*100” without the quotes and press enter.

Practical Example to Illustrate How it Works

To understand the concept better, it’s best to check from a practical example.

Let’s assume that you invested in a mutual fund and made nine investments of INR 5,000 for nine months, from 11 January 2024 to 11 September 2024. On 11 October 2024, the final redemption value is INR 50,000.

SIP Transaction Dates	Cash Flow in INR (or other currency)	Cash Flow Type
11-01-2024	-5000	SIP Amount
11-02-2024	-5000	SIP Amount
11-03-2024	-5000	SIP Amount
11-04-2024	-5000	SIP Amount
11-05-2024	-5000	SIP Amount
11-06-2024	-5000	SIP Amount
11-07-2024	-5000	SIP Amount
11-08-2024	-5000	SIP Amount
11-09-2024	-5000	SIP Amount
11-10-2024	50000	Final Redemption Value
XIRR	28.2522293

Now, let’s take a look at how you can calculate your XIRR value practically:

Step 1: Create the Table

Create a table as shown in your Excel or Google Sheets spreadsheet. Add headers SIP Transaction Date, Cash Flow in INR (or other currency), and Cash Flow Type on cells A1, B1, and C1, respectively.

Step 2: Record All Data

Under column A, enter all dates of cash flow as shown. Ensure the date format is right.

Under column B, enter the respective cash flow amount against every date as mentioned, including SIP amounts with a negative sign and a positive final redemption value.

Under column C, enter the cash flow type for clarity.

Step 3: Apply the Formula

In the last row, enter XIRR in column A and the formula “=XIRR(Values, Dates, [guess])*100” on the corresponding cell in column B. Here, the formula will be: =XIRR(B2:B11, A2:A11)*100 and hit enter.

Note: We’ve left the guess value empty as it’s an optional argument.

This calculates the XIRR value for you. In this example, it comes out as 28.2522293%.

Step 4: Interpret the Result

The XIRR value of 28.2522293% indicates that your mutual fund investments produced a return of 28.2522293% on an annual basis. This calculation considers all irregular cash flows.

It will help you If you want to save time and avoid getting into complex calculations, use the PowerUp Money SIP calculator. It will help you quickly assess your investment performance and project future returns based on your specific cash flow patterns, making it easier to plan your financial goals.

To Wrap Up

XIRR is an important tool for every investor dealing with mutual funds and irregular cash flows. It helps to analyse your investments and portfolio performance.

By factoring the time of each transaction, XIRR represents your returns far more accurately than CAGR. It reflects the investment growth or decline and lets you make well-informed financial decisions.

With this knowledge, start investing in mutual funds, compare them, and ensure alignment with your financial goals!

[Disclaimer: The information in this article is for informational purposes only and should not be considered financial advice. PowerUp Money is not liable for errors, omissions, or outcomes from using this information. Please consult a financial advisor before making investment decisions.]

FAQs

1. How much of the XIRR percentage is profitable for mutual funds?

A profitable XIRR percentage for equity mutual funds is usually 12%. This benchmark helps investors gauge whether their investments yield satisfactory returns compared to market averages.

2. Is XIRR annually compounded?

No, it follows a daily compounding rule to evaluate returns on investment. This approach provides a more accurate reflection of returns, especially for investments with varying cash flows over time.

3. How does XIRR differ from CAGR?

CAGR presupposes a single investment over a predetermined period, but XIRR compensates for multiple cash flows at unpredictable intervals. Because of this, XIRR becomes a more useful metric for mutual funds whose contributions and withdrawals fluctuate.

4. Why is XIRR important for investors?

XIRR offers a comprehensive view of an investment’s performance by considering the timing and amount of cash flows. This helps investors make more informed decisions about their portfolios, maximising their potential returns.