XIRR vs CAGR: Key Differences, Calculations and Application

Understating and evaluating the performance of any investment is necessary to make more informed decisions. XIRR and CAGR are the two most popular metrics for evaluating the return on your mutual fund investments. While both offer valuable insights, they serve different purposes and are suited to different types of investments.

In this blog, we will cover the concept of XIRR and CAGR, the key differences between XIRR vs CAGR, their limitations, and more. Keep reading!

What Is CAGR?

CAGR (Compound Annual Growth Rate) is a metric used to measure the returns generated by an investment. CAGR captures the rate of return every year by factoring in the initial investment value, time elapsed, and final value. It does not account for the fluctuation of the capital inflow or outflow. Hence, this metric is ideal for comparing various investments over the same period.

Mathematically, CAGR can be expressed as:

CAGR = (Final Value of Investment/ Initial Value of Investment) ^1/n – 1 (where n = investment period in years)

What Is XIRR?

XIRR (Extended Internal Rate of Return) is another metric that is used to measure the annualised return on investment generated from irregular cashflows with more accuracy. Usually, XIRR is used to measure the returns generated on investments where funds are invested and withdrawn at various points in time.

It is mainly used to calculate returns from irregular investments along with partial withdrawals, such as real estate projects, multiple systematic investment plans (SIPs) in mutual funds, etc.

Rate calculations in MS Excel w.r.t. investments:

MS Excel does not have a CAGR function. The broad guidelines on which MS Excel function to use is as per the table given below.

Type of Cash Inflow	Type of Cash Outflow	Amount in Cashflow	Frequency of Cash Flow	Scenario	MS Excel Function to Used (##)
Single	Single	Uniform	Uniform	Lumpsum Investment & Withdrawal on Maturity	Rate (PV is Lumpsum Investment, FV is Maturity amount, Nper is years)
Regular	Single	Uniform	Uniform	Sip investment & withdrawal on maturity	Rate (PMT is sip, FV is maturity amount, Nper is “years*12”)
Single & regular	Single	Uniform	Uniform	Sip & lumpsum investment in the same fund initially & withdrawal on maturity	Rate (PV is lumpsum investment, PMT is sip, FV is maturity amount, Nper is “years*12”)
Single	Regular	Uniform	Uniform	Lumpsum investment & swp till money is available	Rate (PV is lumpsum investment, PMT is swp, FV is 0, Nper is “years*12”)
Single	Regular & single	Uniform	Uniform	Lumpsum investment & swp during withdrawal phase plus lumpsum maturity amount	Rate (PV is lumpsum investment, PMT is swp, FV is maturity amount, Nper is “years*12”)
Regular	Single	Non-uniform	Uniform	Sip investment but sip pause or sip missed (date or amount) & withdrawal on maturity	XIRR
Regular or single	Single & regular	Non-uniform	Non-uniform	Sip or lumpsum investment or both but random partial withdrawal is done before maturity & withdrawal on maturity	XIRR
Multiple sips running parallel	Single	Uniform for each sip	Uniform for each sip	Multiple sips maturing on same or different date	XIRR
Multiple investments (dates of investments are available)	Multiple withdrawals (dates of withdrawals are available)	Non-uniform	Non-uniform	Assessing returns on investor portfolio held for a period of time	XIRR

## Follow Time Value of Money Sign Conventions

XIRR vs CAGR: Key Differences

Here are some of the key differences between CAGR and XIRR presented in a tabular format:

Point of Difference	CAGR	XIRR
Cashflow	It assumes a single initial investment value and a final value.	It calculates annualised returns from multiple, irregular cashflows.
Timing Sensitivity	CAGR ignores the timings of each instalment within the period of investment.	The XIRR accounts for the exact dates for cashflows.
Real-World Application	Stocks, lump sum mutual fund, and performance of market indices.	Multiple SIPs, SIPs where SIP Stop or SIP Pause has been exercised, real estate, and private equity investments.
Accuracy for Variable Investments	It is accurate for single cashflows. For uniform cashflows, Rate function in MS Excel needs to be used.	It’s more accurate.
Period Flexibility	It assumes a fixed time period.	It handles varying time periods.
Best Used For	Single investments held over a set period.	Portfolio returns where multiple investments & withdrawals happen.

CAGR vs XIRR for SIP:

Assessing XIRR or CAGR,  its totally depends on the investment scenario and the type of investment you are trying to gauge. Both XIRR and CAGR come with their own pros and cons, and each is suitable for different investment scenarios.

CAGR is an appropriate metric if you are gauging the returns of lump sum investments, analysing market trends, or drawing a comparison between various investment options. It is an easy-to-use tool and helps to draw conclusions from volatile and inconsistent data.

On the other hand, if you are dealing with investments with multiple cash flows at irregular intervals, XIRR is a better choice. Such types of investments include multiple mutual fund SIPs, investments in private equity, investments in real estate projects, portfolio return evalution etc.

When it comes to evaluating multiple systematic investment plans running parallely, XIRR is an ideal choice. This is because XIRR takes into account each investment (cash inflow) or withdrawal (cash outflow) made over time.

Limitations Associated with XIRR and CAGR

Both CAGR and XIRR are powerful metrics for evaluating your return on investments. However, both of them come with various limitations, which are as follows:

Limitations of XIRR:

• Minor errors can have a large impact; even a small mistake in the dates can entirely change the results.
• XIRR is based on the assumption that cashflows can be reinvested at the same rate, which is not always the case.
• XIRR calculations are comparatively more complex and require financial calculators or software/ Application or MS Excel

Limitations of CAGR:

• CAGR tends to ignore short-term volatility and smooths out year-to-year fluctuation, which can hide short-term fluctuations.
• It takes into account the investment value at the beginning and end, ignoring any kind of extra investments or withdrawals in between.
• Looking at CAGR values in isolation over certain periods (when investment value was very low or high) can lead to misleading results.

Conclusion

Both CAGR vs XIRR are crucial metrics for calculating the return on investment in various investment avenues and scenarios. XIRR is more suitable when it comes to measuring returns on investments made at irregular intervals. On the other hand, if you are willing to gauge the returns of a lump sum investment or the performance of a market index, CAGR can be a better choice.

By knowing when to apply each metric, you will be able to make more informed decisions and better assess the true performance of your investments.

Frequently Asked Questions

1. XIRR vs CAGR?

XIRR or CAGR entirely depends on the investment scenario. XIRR can be a good option when it comes to measuring returns on investments made at irregular intervals. On the other hand, if you are willing to measure the returns of a lump sum investment or the performance of a market index, CAGR can be an appropriate choice.

2. Are annualised returns and CAGR the same?

CAGR is a type of annualised return assuming growth at a steady rate year over year, making it a more precise measure of compounded growth. There are other types of annualised returns, including absolute returns, rolling returns, and IRR (internal rate of returns).

3. Can we convert XIRR to CAGR?

No, XIRR and CAGR cannot be directly converted into one another because they measure different aspects of investment returns. XIRR accounts for cashflows occurring at irregular intervals, whereas CAGR assumes a single lump-sum investment and a steady growth rate.

4. Why is XIRR used to calculate returns from SIP and not CAGR?

XIRR is used to calculate returns from multiple mutual funds SIPs running parallelly as it accounts for multiple and irregular cashflows as a result of withdrawals, additional investments, etc. To calculate returns of SIP investment in a single fund, RATE function in MS Excel needs to be used. CAGR, on the other hand, is more suitable for a single lump-sum investment made at the start of the period.

5. What is a good value of  XIRR for a particular investor?

A good XIRR entirely depends on the context, including the risk level of the investment and the investor's expectations. A good XIRR in mutual funds can depend on several factors, such as individual risk tolerance and market conditions.

6. Which is better: CAGR or absolute return?

CAGR is preferable because it provides more clarity on investment performance over time, whereas absolute return simply ignores the time of these factors. Absolute Returns is used when investment horizon is less than one year to avoid annualization. It is also used to calculate point-to-point returns of single investment like real estate.

 

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