What is XIRR in Mutual Funds?

Mutual funds have become a famous investment avenue due to their potential for steady returns and professional management.

While most investors focus on the fund’s past performance, understanding how to calculate and interpret returns is equally critical.

Your cash flow (investments and withdrawals) may be inconsistent when you invest in mutual funds. This is where XIRR (Extended Internal Rate of Return) comes into play. It helps you measure the annualized returns from these irregular cash flows, giving you a more accurate picture of your investment’s performance.

This blog explains XIRR, its importance, and how it differs from CAGR (compound annual growth rate). We’ll also discuss calculating XIRR and identifying what qualifies as a good XIRR in mutual funds.

What is XIRR in Mutual Funds?

XIRR stands for Extended Internal Rate of Return. It calculates the annualized return on an investment with multiple cash flows made at irregular intervals. Unlike traditional metrics like CAGR, XIRR considers both the timing and the amount of each cash flow, making it particularly suited for Systematic Investment Plans (SIPs) or Systematic Withdrawal Plans (SWPs).

For example, Suppose you invest ₹10,000 monthly in a mutual fund. After a year, your total investment is ₹1,20,000, and the value of your investment has grown to ₹1,30,000. XIRR calculates the exact annualized return based on the timing of each ₹10,000 contribution and the final redemption amount.

Why is XIRR Important in Mutual Funds?

Accounts for Irregular Cash Flows

Mutual fund investments are often made through SIPs, where equal amounts are invested periodically. However, life is unpredictable, and you may occasionally skip SIPs, make additional investments, or withdraw funds. XIRR factors in these irregularities, offering a more realistic measure of returns.

Helps Track SIP Returns

SIPs are a preferred mode of investing. However, evaluating their returns can be tricky because the money invested earlier has more time to grow than recent contributions. XIRR ensures that this compounding effect is accurately reflected.

Allows Better Comparisons

XIRR makes comparing returns across funds or investment strategies more meaningful. It helps you see the true annualized returns of each investment, even if the cash flows differ in timing and amount.

XIRR vs. CAGR: Key Differences

Particulars	XIRR	CAGR
Definition	Calculates annualized returns for irregular cash flows over time	Calculates annualized returns assuming a lump-sum investment.
Applicability	Best for SIPs, SWPs, or staggered investments and withdrawals.	Ideal for lump-sum investments with no intermediate cash flows.
Accuracy	Accounts for both the amount and timing of each cash flow.	Assumes a single cash flow at the beginning of the period.
Complexity	It is a complex calculation as it requires both inflow and outflow.	Easy to calculate by taking the invested amount into account.

Example for Better Understanding:

Imagine two investors

Investor A: Invested ₹1,00,000 as a lump sum and redeemed ₹1,50,000 after three years. Here, CAGR can calculate returns accurately as there’s only one cash inflow and one outflow.

Investor B: Invested ₹10,000 every month for three years and redeemed ₹4,50,000 at the end. For this scenario, CAGR cannot account for the timing of each ₹10,000 investment, making XIRR the appropriate metric.

How to Calculate XIRR?

Calculating XIRR manually can be cumbersome as it requires iterative methods to solve for the return rate. However, tools like Excel or Google Sheets make the process simpler.

Steps to Calculate XIRR in Excel:

1. List Dates: Create a column with all the dates when investments or withdrawals were made.
2. Enter Cash Flows: In a second column, record the investment amounts as negative values (cash outflows) and the redemption amount as a positive value (cash inflow).
3. Apply Formula: Use the formula =XIRR(values, dates) to calculate the annualised return.

Date	Cash Flow
01-Jan-2023	-10,000
01-Feb-2023	-10,000
01-Dec-2023	1,30,000

4. Here, you invested ₹10,000 in January and February and redeemed ₹1,30,000 in December.
5. Applying the Excel formula =XIRR(B2:B4, A2:A4) gives you an annualized return of around 32%.

What is a Good XIRR in Mutual Funds?

A good XIRR varies depending on the type of mutual fund and the market conditions.

1. Equity Mutual Funds: Since equity funds carry higher risk, they aim for higher returns. A good XIRR for equity funds typically ranges between 12% and 15% over the long term.
2. Debt Mutual Funds: Debt funds offer lower risk but deliver moderate returns. A good XIRR for these funds is around 6-8%, aligning with their safer nature.

Balanced/Hybrid Funds: For funds with a mix of equity and debt, 10-12% XIRR is considered reasonable.

CAGR vs. XIRR: When to Use What?

1. Use CAGR when:
   1. Evaluating returns on lump-sum investments.
   2. Comparing the historical performance of funds.
2. Use XIRR when:
   1. Tracking returns from SIPs or irregular investments.
   2. Evaluating returns for a portfolio with multiple cash flows.
   3. Calculating returns for funds with periodic withdrawals.

Conclusion

Understanding and analyzing returns is crucial for mutual fund investors, especially when dealing with irregular cash flows like SIPs or withdrawals. This is where XIRR stands out, offering a precise calculation of annualized returns by accounting for the timing and size of each cash flow. Unlike CAGR, which assumes a single lump-sum investment, XIRR mirrors real-world investment patterns, making it a valuable tool for modern investors.

Knowing your XIRR empowers you to evaluate fund performance more effectively, compare different strategies, and align your portfolio with your financial goals.