XIRR in mutual funds-Meaning, importance & calculation

Investing in mutual funds has multiple benefits like tax savings, the flexibility of investment, lower costs, etc. The ability of mutual funds to generate better and more or less stable returns at manageable risks is considered to be one of many such benefits. But it is not always easy to calculate returns available through mutual funds, especially in the case of SIPs. This is where XIRR comes into the picture. Learn what is XIRR and how to calculate it for mutual funds

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What is the meaning of XIRR in mutual funds?

XIRR stands for the Extended Internal Rate of Return. This is a method of calculating the annualized return on investment for financial instruments, especially mutual funds. XIRR is widely used in calculating annualised returns in mutual funds as it takes into account the timing and size of all cash flows, as well as investments and withdrawals. The returns are calculated based on the actual dates of the cash flows. XIRR is therefore widely used in the calculation of annualised returns in the case of mutual funds investment through SIPs (Systematic Investment Plans) or SWPs (Systematic Withdrawal Plans) as it provides a more accurate measure of the actual return on investment. 

Steps to calculate XIRR for mutual fund investment

XIRR is an inbuilt function in MS excel and is used by investors, analysts, financial advisors, and fund managers to simplify the efforts in the calculation of XIRR. The steps to calculate the XIRR in MS Excel are given below. 

1. The first step is to tabulate all the cash flows  (investments and purchases to be marked in negative) and their corresponding dates in two adjacent columns.
2. The last data entry in the excel should be the current redemption amount (marked as a positive entry) and the current date in respective columns.
3. The next step is to use the XIRR formula by selecting the cells as per the syntax.
4. The required syntax is XIRR (values, dates, [guess])
5. The Guess parameter is optional (if no value is put against it, excel uses a value of 0.1) and runs the calculation until the result is accurate within 0.000001%.

Why is XIRR important in mutual funds?

XIRR is a widely used measure to calculate annualised returns for mutual fund investments as it provides more precise and accurate results after considering the timing of the cash flows as well as its size. The importance of XIRR in mutual funds is highlighted below. 

Calculating the exact returns in the case of SIPS and SWPs

XIRR is used to calculate mutual fund investment returns in the case of SIPs and SWPs that requires regular investment and withdrawals at regular intervals. This measure accounts for the timing of the cash flows making it a more accurate measure of evaluating mutual funds investments. 

Performance evaluation of mutual funds

XIRR can be used to evaluate different mutual fund options and make efficient investment decisions to create a successful investment portfolio.

Measurement of actual returns

XIRR is used to measure exact returns on mutual funds investments taking into account the fees and expenses for such investment and otherwise. This helps investors understand the impact of the fees and other charges of investing in mutual funds on the actual returns from the same. It can ultimately be used for better comparison between multiple mutual fund options or managing the cost of investment. 

What is the difference between CAGR and XIRR?

CAGR and XIRR are both used to calculate investment returns over a period of time. However, there are a few key differences between the two. These differences are highlighted below.

Category	XIRR	CAGR
Method of calculation	XIRR accounts for the actual size and timings of the cash flows for investments and withdrawals. Therefore, it is a more preferred mode of calculating annualised returns in the case of mutual fund investments through SIPs or SWP mode.	CAGR on the other hand is a calculation of a simple average rate of return where a constant growth rate is assumed over the investment period.
Cash flows	XIRR accounts for all cash flows in the calculator of annualised returns.	CAGR does not account for the timing and the size of the cash flows in the calculation of the annualised returns in investments and withdrawals.
Accuracy	XIRR provides a more accurate and precise version of the annualised returns as compared to CAGR.	CAGR can represent an overestimate or underestimate of the actual return, especially when there are significant cash flows involved
Use of the measure	XIRR is a more appropriate tool for evaluating the performance of an investment that has variable returns over a period of time.	CAGR is a more commonly used tool for comparing the performance of investments with a fixed annual rate of return.

Conclusion

XIRR is an important tool for evaluating the performance of mutual funds and other financial instruments. It can help investors make informed investment decisions to create a healthy investment portfolio. This helps in better understanding the true cost and impact of fees and expenses of mutual fund investments. 

FAQs

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