XIRR In Mutual Funds: Meaning, Types & Importance Explained

What is XIRR?

XIRR stands for Extended Internal Rate of Return. Any investment’s main goal is to generate returns. Returns could take the shape of income, capital growth, or perhaps both. Compound annual growth rate (CAGR) and XIRR are the two most used metrics for mutual fund returns. CAGR, as the name suggests, is the rate of growth of your investment, assuming annual compounding, during the investment period. While XIRR in mutual funds can be applied for multiple cash flows, CAGR or point-to-point returns are not applicable or cannot be employed in the case of multiple cash-flows. When there are many transactions occurring at various periods, the XIRR formula is used to determine investment returns.

Why Does it Make Sense for Mutual Fund Investments?

If your spending is evenly spaced out throughout time, you can use this principle to calculate how much money you have made from your investments.

Nevertheless, assets are typically not distributed as uniformly as you saw above for mutual funds. With mutual funds, you frequently make investments and redeem them at random times.

At various times, it will result in cash inflows and outflows. In this kind of situation, in addition to the quantity invested, the timing of such an investment also gains relevance to produce a particular result.

Use the extended internal rate of return notion here (XIRR).

So, when your cash flows (investments or redemptions) are dispersed over time, XIRR is a good function to calculate returns. In the case of mutual funds, XIRR can handle all those eventualities and assist you in calculating a consolidated return taking timings of your investment and withdrawals into consideration. You can invest using SIP or lump-sum, or redeem using SWP or lump-sum.

XIRR Calculation

MS Excel makes calculating XIRR simple. A built-in function of the XIRR calculator in Excel can be used to determine XIRR. For computing the annualised yield for a schedule of cash flows happening at irregular intervals, Excel’s XIRR function is more potent.

Excel’s XIRR formula is: = XIRR (value, dates, guess)

The steps are as follows for Excel:

1. Transactions to be entered in one column and all outflows such as purchases to be marked negative and inflows like redemption market positive
2. Add corresponding date of transaction to next column
3. Mention current value of holding in last column
4. XIRR function in excel to be used here
5. Select values to a series of cash flows corresponding to a schedule of payments

Example of How to Use the XIRR Function in Excel

If you invest through a Systematic Investment Plan (SIP) with irregular intervals, the XIRR function in Excel helps calculate the exact return on your investment. Let’s go through an example using a six-month SIP in 2024.

Investment Details:

• SIP Amount: ₹ 6,000 per month
• Investment Start Date: 02/01/2024
• Investment End Date: 02/06/2024
• Redemption Date: 02/07/2024
• Maturity Amount: ₹ 36,000

Below is the cash flow table representing investment outflows (negative values) and redemption inflow (positive value):

Steps to Calculate XIRR in Excel:

1. Open Excel and prepare two columns: one for dates and one for cash flows associated with those dates.
2. In the ‘Date’ column, enter the dates when the SIP investments were made and the date of redemption. In the ‘Cash Flow’ column, enter the corresponding amounts invested (as negative values) and the maturity amount (as a positive value). Your table should look like the above table.
3. After entering the data, use the XIRR function to calculate the internal rate of return. Click on an empty cell where you want the result to be displayed.
4. Enter the XIRR formula: =XIRR(B2:B7, A2:A7). Here, B2:B7 represents the range of your cash flows, and A2:A7 represents the range of corresponding dates.
5. Press Enter to calculate the internal rate of return for your SIP investment.

Remember, the XIRR function returns the result as a decimal, so you might want to format it as a percentage to make it easier to read. The calculated return rate reflects the annualised yield on your investment, considering the specific timing of each cash flow.

Understanding XIRR in Account Statements

Mutual fund providers issue Account Statements (AS) to investors, offering a detailed overview of their investments. These statements include essential information such as the average investment cost per unit, total units held, total investment amount, current valuation, and annualised returns.

The annualised returns are calculated using the widely recognised XIRR method, which takes into account both Net Asset Value (NAV) growth and dividends received over the investment period.

XIRR provides a standardised measure of investment performance, making it a useful tool for comparing the returns of different mutual fund schemes. By evaluating XIRR values, investors can assess performance based on investment duration and market conditions, enabling them to make well-informed decisions about their portfolios.

Understanding XIRR in SIP Investments

XIRR (Extended Internal Rate of Return) is a method used to calculate annualised returns for investments that have irregular cash flows. In a Systematic Investment Plan (SIP), where contributions are made at different times, the exact investment dates and amounts can vary.

Unlike basic return calculations, which may not account for these variations, XIRR provides a precise measure of investment performance by factoring in both the timing and value of each transaction. This makes it a more accurate tool for evaluating SIP returns.

For investors, XIRR plays a crucial role in assessing real investment performance, offering a better alternative to simplified return calculations. It is particularly beneficial when comparing different investment options and helps in making well-informed financial decisions.

Whether investing in mutual funds or stocks through SIPs, using XIRR ensures a clearer understanding of annualised returns, allowing for better financial planning and portfolio optimisation.

Importance of XIRR in SIP

• Accurate return calculation: XIRR provides a precise measure of SIP returns by considering the exact dates and amounts of each investment, offering a true reflection of growth.
• Accounts for irregular investments: Unlike traditional return calculations, XIRR factors in variations in investment amounts and frequency, ensuring a more reliable performance analysis.
• Effective comparison tool: Helps investors compare returns across multiple SIPs or financial instruments, making it easier to identify high-performing investments.
• Enhances financial planning: Supports goal setting, progress tracking, and necessary adjustments to improve investment outcomes.
• Encourages long-term commitment: Understanding your exact returns keeps you motivated and focused on your SIP strategy.

Limitations of XIRR

• Requires accurate data: XIRR relies on precise cash flow data, including exact dates and amounts. Any errors can impact the accuracy of the results.
• Highly sensitive to changes: Even minor alterations in cash flow data can significantly affect the XIRR calculation, making it challenging to compare different investments reliably.
• Not suitable for all investments: While ideal for irregular cash flows like SIPs, private equity, or real estate, XIRR may not be as effective for fixed-income investments such as bonds or annuities.

Can We Use CAGR Instead for Calculating Returns?

When we want to invest in a mutual fund, we first look at its results over the previous three, five, etc. years. These returns are point-to-point returns and are denoted by the acronym CAGR, or compound annual growth rate.

CAGR is easily determined by applying the following formula:

CAGR = ((Ending Amount/Beginning Amount)^(1/No. of years)) – 1

This common statistic is used to estimate investment returns in many mutual funds. While calculating CAGR for a mutual fund is simple, doing it for individual investments can be a little challenging.

Importance of XIRR in Mutual Funds

Thankfully, you can use the XIRR method in Excel sheets to handle irregular cash-flow times. Simply said, XIRR is IRR modified to allow for the flexibility of assigning precise dates to individual cash flows, making it a considerably more accurate method of calculating returns. You only need to enter the transactions (SIP/SWP installments, additional purchases, redemptions, etc.) and the relevant dates to find out the XIRR for mutual funds. You can use the XIRR formula in an excel sheet to obtain these transactional facts from the statement of account that the fund firm sent.

Conclusion 

We covered the significance of XIRR in mutual funds in this post, as well as how to utilise it to estimate various cash flows, such as SIP, Systematic Withdrawal Plan (SWP), extra purchases, dividends, partial redemptions, etc. CAGR is a term that is well-known among investors. Similar to CAGR, XIRR in MF employs the idea of compounding; in fact, you may consider XIRR to be an accumulation of CAGRs. If your mutual fund investments have multiple cash flows, you must use XIRR.

FAQs