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What is XIRR in Mutual Funds & How to Calculate XIRR?
Ever wondered what would be the best way to determine the return on a mutual fund investment? Here, there are two methods an investor can use to calculate: XIRR and CAGR. XIRR, or Extended Internal Rate of Return, is the method to calculate mutual fund returns accurately. It is ideal for investment with multiple cash flows, like SIPs and withdrawals.
CAGR assumes that the investment was made all at once. Whereas XIRR considers the timing and amount of every transaction, giving a more realistic measure of returns. Let's learn what is XIRR in mutual funds, its importance, and the calculation process.
Table of Contents
What is XIRR?
XIRR, or Extended Internal Rate of Return, is a single rate of return used when investors make multiple investments at different points in an investment vehicle such as a mutual fund.
This single rate of return is applied to all transactions (including investment and redemption) to calculate the current rate of return and the current value of the entire investment.
XIRR is the real investment return.
Importance of XIRR in a Mutual Fund
A modified version of IRR, XIRR, is necessary for investing in mutual funds. It is because, using it, investors can compute the right results from the data showing uneven cash flow intervals. Let us dive deeper into its importance in mutual funds:
1. For Accurate Return Calculation
XIRR calculates actual portfolio returns considering exact dates for investment and withdrawals instead of relying on simple returns.
2. For Redemption Purposes
XIRR considers the redemptions, performs correct return measurements, and provides timely measurement of fund performances to investors.
3. For Return Measurement of Various Mutual Funds
XIRR helps compare the performance of various mutual funds with different kinds of investments and holdings.
Why Does XIRR in a Mutual Fund Make Sense?
XIRR in a mutual fund is crucial because this metric gives the actual return value for multiple investments and withdrawals and more accurately determines returns, unlike CAGR or simple averages presupposing a singular investment.
It allows for every exact date of the cash flow for a realistic investment review. Let's explain this with the help of an example:
Suppose an investor has invested in the following mutual fund investments:
- The simple average or CAGR calculation would miss the timing of these investments and give a misleading result.
- XIRR adjusts for these variations by evaluating returns based on the duration each amount remains invested.
For example, if the fund is delivering high growth between March and June, the March invested ₹5,000 is better off than the ₹10,000 invested before March. Thus, XIRR correctly weighs cash flows so that the return rate indicated would reflect real-world investment performance.
What is a Good XIRR in Mutual Funds?
In mutual funds, a good XIRR depends upon three main factors: type of fund, market, and investor-related variables such as timeline and objectives. Here is an ideal XIRR percent in a mutual fund:
Generally, a good XIRR outperforms inflation and aligns with the investor's financial goals over the desired time horizon.
What is the Formula for Calculating XIRR in Mutual Funds?
The extended internal rate of return generally refers to the calculation for XIRR by the mutual funds' formula that seeks a discount rate whose net present value of all the cash flows is a sum of zero. The formula is:
= XIRR(values, dates, guess)
Where,
- values = Cash flows (investment amounts and redemptions)
- dates = Corresponding transaction dates
How to Calculate XIRR in Mutual Funds?
XIRR can be calculated in MS Excel using the XIRR function. To do this, you must enter the transaction amount and its dates. Here is the step-by-step process to calculate it:
- Step 1: Enter Transactions and Dates:
- In Column A, enter the transaction dates (investment and redemption dates).
- In Column B, enter the corresponding amounts for each transaction. Use negative values (since it's an outflow) for investments or purchases, and for the redemption amount, use the positive value.
- Step 2: Add the Final Investment Value: In the last row of Column B, enter the current value of the investment (e.g., redemption amount).
- Step 3: Apply the XIRR Function: Use the XIRR function to calculate the return in an empty cell. The formula for it is =XIRR(values, dates). After entering, press Enter to get the XIRR.
Here's an example to understand its calculation better:
Let's assume you start an SIP of ₹10,000 on January 10, 2023, and continue to invest the same amount every month on the same date. Your investment matures on December 10, 2023, and you receive ₹1,30,000.
Here's how you'd structure the data in Excel:
Steps in Excel:
- Column A (Dates): Enter the transaction dates as shown above.
- Column B (Transaction Amounts): Enter the amounts as negative for investments and positive for the redemption value.
- In an empty cell, enter the formula: =XIRR(B1:B12, A1:A12)*100
- Press Enter to get the XIRR value, representing the annualised return for the cash flows. Multiply by 100 to convert it to a percentage. You'll get the XIRR value of 18.4%.
This process calculates your SIP return accurately, considering the timing of each investment and the final redemption amount.
What are the Points to Remember While Calculating XIRR?
1. Accurate Cash Flow Dates
Correctly enter all cash flow dates into the system. The timing of investments and redemptions greatly influences XIRR computation results.
2. Correct Cash Flow Values
Redemption cash flows should enter as positive values, while investment cash flows should carry negative values.3. Consistency in Time Units
All dates within the same cash flow timeline should have equal time attributes (days, months, and years).4. Use of Excel or Financial Tools
XIRR calculations should be handled with Excel tools such as XIRR because these tools quickly handle XIRR computations.
5. Risk of Incorrect Results
Input errors during cash flow recording are commonly mistaken as missing or imprecise dates, leading to XIRRs producing incorrect results.6. Investment Horizon Impact
XIRR analysis reveals more substantial impacts from long-term investments, which show compounded growth.
What are the Advantages of Using XIRR in Mutual Funds?
The XIRR account takes care of the timing of every cash flow, providing a relatively comprehensive picture of the investment's performance. The main benefits of using XIRR in mutual funds are as follows:
1. Accurate Measurement of Returns
XIRR considers the exact dates of cash flows, so it is more reliable than simple average returns or CAGR.
2. Handles Multiple Investments
Unlike traditional methods, XIRR efficiently manages multiple investments and withdrawals simultaneously.
3. Real-time Performance
The XIRR considers the real-time market fluctuations for every investment. Hence, it gives an actual measure of returns.
4. Perfect for SIPs
XIRR calculates staggered investment more accurately, thus making it ideal for SIPs.
5. Helps Fund Comparison
Investors can compare mutual funds fairly despite investment size and date variations.
6. Redemption Impact
XIRR also accounts for redemption, showing redemptions' impact on all returns.
Limitations of XIRR in Mutual Funds
The XIRR implementation is constrained under various conditions because its intrinsic assumptions do not apply well to fully real-world investment scenarios. Here are some key limitations:
1. Assumes Reinvestment of Returns
XIRR assumes that returns are reinvested at the same rate. This may not be practical in the real world.
2. Sensitive to Cash Flow Timing
The return calculation is very sensitive to the dates of cash flows. Therefore, entries must be made with precision.
3. Difficulty for New Investors
XIRR is challenging for new investors to calculate using Excel or financial calculators until they gain experience.
4. Ignore Market Conditions
XIRR only considers cash flows and ignores market conditions and other external factors that affect the performance of funds.
5. Include Taxes and Fees
XIRR does not account for taxes, exit loads, or fees, which affect actual investor returns over time.
XIRR vs IRR
Although both terms seem very similar, they differ in specific terms. IRR gives perfect results for structured investments wherein the cash flows happen at regular periods, but XIRR manages cash flow timelines that are not periodic. The key differences between XIRR and IRR have been given below in the following table:
In conclusion, both XIRR and IRR help evaluate investment returns, but XIRR is more practical for real-life investments like mutual funds, where cash flows are irregular. In contrast, IRR is better suited for structured investments with equal cash flow intervals. Investors should choose the right metric based on their investment structure for an accurate performance assessment.
Disclaimer: The information provided on this website is for general informational purposes only and should not be construed as financial, investment, or legal advice. While we strive to provide accurate and up-to-date content, we do not guarantee the completeness, reliability, or suitability of the information for your specific needs.
We do not promote or endorse any financial product or service mentioned in these articles. Readers are advised to conduct their own research, consult with financial experts, and make informed decisions based on their unique financial circumstances. Any reliance you place on the information provided here is strictly at your own risk.
FAQs about XIRR in Mutual Fund
1. What is the full form of XIRR?
2. What is XIRR in a mutual fund?
3. What are the benefits of using XIRR in mutual funds?
The benefits of XIRR include:
- Provides accurate annualised returns for investments with multiple transactions.
- It helps compare different mutual funds effectively.
- Accounts for the timing of investments and withdrawals.
Why is XIRR important in mutual funds?
What is the formula to calculate XIRR?
The formula to calculate XIRR is =XIRR(values, dates, guess)
Where,
- values = Cash flows (investment amounts and redemptions)
- dates = Corresponding transaction dates
What is a good XIRR in mutual funds?
What is the difference between XIRR and absolute return?
Are XIRR and CAGR the same?
What are the limitations of XIRR?
The limitations of XIRR include:
- Assumes reinvestment of returns at the same rate.
- Sensitive to cash flow dates.
- Doesn't account for taxes and fees.
Can XIRR go negative?
Is 12% XIRR good?
What does 20% XIRR mean?
What does 10% XIRR mean?
Is XIRR better than CAGR?
Can XIRR be converted to CAGR?
Is XIRR compounded annually?
Can I enter all cash outflows as positive values while calculating with XIRR in a mutual fund?
Does XIRR use the concept of compounding?
Yes, XIRR in mutual funds uses the concept of compounding by calculating the returns based on the actual cash flow dates. Thus ensuring more accurate growth projections.
Other Important Articles about Mutual Funds
Disclaimer
- This is an informative article provided on 'as is' basis for awareness purpose only and not intended as a professional advice. The content of the article is derived from various open sources across the Internet. Digit Life Insurance is not promoting or recommending any aspect in the article or its correctness. Please verify the information and your requirement before taking any decisions.
- All the figures reflected in the article are for illustrative purposes. The premium for Coverage that one buys depends on various factors including customer requirements, eligibility, age, demography, insurance provider, product, coverage amount, term and other factors
- Tax Benefits, if applicable depend on the Tax Regime opted by the individual and the applicable tax provision. Please consult your Tax consultant before making any decision.
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