XIRR in Mutual Funds

What is XIRR in Mutual Funds?

XIRR, also known as Extended Internal Rate of Return, is an essential tool for figuring out how well your investments are doing, especially when money is deposited and withdrawn at different intervals. XIRR may be a complex term that helps you calculate the annualized returns over a certain period of time, specifically when the amounts are invested at different points of time over that same period. 

Say, we did a monthly investment of Rs.10/- over a period of 5 years. The total investment amount is 600/- over 5 years (60 months).

If we know the final return amount, we can calculate the returns (%) accounting for the following scenario. The Rs.10 we invested in the first month has earned interest for the whole period of 60 months and the Rs.10 we invested in the 60th month has earned interest only for a period of one month. If we skipped investing for a few months in between then obviously our total investment amount becomes lower than 600/-. 

Most of us may or may not invest all our money at once, or even monthly. We may skip a few months. We may add more because we have some extra capital. We may even withdraw money at certain times. XIRR tells us the returns we have made on our investments that are spread out assuming all our investments made the exact same return. 

The return (%) that we get after accounting for the above scenario is called XIRR.

How is XIRR different from absolute return, CAGR and IRR?

Absolute return is a simple metric that shows an investment's total gain or loss over a specific period. It's calculated as the final investment value minus the initial value, divided by the initial value.

CAGR (Compound Annual Growth Rate) is a metric used to calculate the average annual growth of a mutual fund investment over a specific period. It assumes a constant growth rate throughout the investment period, even if the actual returns fluctuate from year to year. This provides a simplified but helpful way to compare the performance of different mutual funds or the same fund over different time horizons.   

IRR (Internal Rate of Return) is used to calculate the returns in case when a series of investments are made over a regular period of time. It may not be applicable for a series of irregular investments and does not account for the timing of investments.

Here's how to calculate CAGR for a mutual fund:

You'll need the beginning and ending investment values for the desired period. This could be the Net Asset Value (NAV) of your mutual fund units at the beginning and end of the investment period.

The formula for CAGR is:
CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) - 1
Ending Value: This is the NAV per unit at the end of the investment period.
Beginning Value: This is the NAV per unit at the beginning of the investment period.
Number of Years: This is the total number of years in the investment period.

Once you have the result, multiply it by 100 to express it as a percentage.

For example, let's say you invested Rs. 10,000 in a mutual fund scheme at a NAV of Rs. 10 per unit (1,000 units) and after 5 years, the NAV grew to Rs. 18 per unit. You can calculate the CAGR as follows:
Ending Value = Rs. 18 per unit
Beginning Value = Rs. 10 per unit
Number of Years = 5
CAGR = ((Rs. 18 / Rs. 10) ^ (1 / 5)) - 1 = 0.1247
CAGR = 12.47%

This indicates that on average, your investment grew at a rate of 12.47% annually over the 5 years in this example.

But CAGR can get a bit complicated when you've been putting money in regularly, like through monthly SIPs. Let's say you've been investing ₹5,000 every month for 3 years, the total investment amount becomes 1,80,000 and at the end of it all, but you may also have made some redemptions for a couple of months in that 3 year period, finally say the returns are 2,00,000. Calculating returns using CAGR for each monthly investment is complicated.Hence, we can use XIRR in this scenario.

How is XIRR calculated?

It is calculated taking into account the timing and amount for multiple cash flows.

Inputs Required:

-Cash inflows and outflows in the Mutual Fund.
-Corresponding dates of these transactions.
-The current value of the Mutual Fund.

Using Excel Formula:

=XIRR(cashflow_range, date_range, [guess])
Here, cashflows represent all cash inflows and outflows (Initial Investment, SIPs, Redemptions. Dates range refers to the dates corresponding to each cash flow).
The guess value, usually set at 10%, offers an initial estimate for the calculation process. If omitted, Excel defaults it to 10% or 0.1.

In this case we have investments done at different times in the month, there was a redemption in between, investment skipped in the month of May, and final redemption in the month of August. 
The -ve values indicate investments and the +ve values indicate redemptions.

XIRR (Values, Dates, [guess] = 0.1) will yield an XIRR of 16.26%.  

What is a good XIRR in mutual funds?

While we may not be able to accurately mention what is a good XIRR, generally, it may be higher for equity mutual funds, while in the case of debt funds, it may be lower when calculated over a long period of time. But one thing to remember is that equity funds are also generally riskier than debt funds. 

Conclusion

XIRR presents the returns when multiple transactions are involved at different time intervals which is very common in case of SIP investments. Hence, it is important for mutual fund investors who invest via SIPs to be aware of this metric and how it is calculated to estimate the performance of their investments in the long run.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully

Please note that this article or document has been prepared on the basis of internal data/ publicly available information and other sources believed to be reliable. The information contained in this article or document is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party in any manner. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article or document.