What is XIRR and its Meaning in Mutual Funds?

XIRR Full Form

XIRR stands for Extended Internal Rate of Return. It is a method used to calculate the returns on investments where there are multiple transactions happening at different times. This is in contrast to the Compound Annual Growth Rate (CAGR), which is only applicable to investments with a single cash flow.

XIRR is commonly used to calculate the returns on Systematic Investment Plans (SIPs) in the following investment options:

• Unit Linked Insurance Plan funds ( or ULIP funds)

• Mutual Funds

A SIP is a method of investing a fixed amount of money in an investment fund every month. There is an online SIP calculator to get the estimated returns on SIP investment. As there are multiple cash flows happening at different times, making it difficult to calculate the returns using CAGR.

To calculate XIRR in a mutual fund or ULIP fund, you need to know the following information:

• Monthly Investment Amount

• Date of Each Investment

• NAV of the ULIP Fund/ Mutual Fund on the Date of Each Investment

Why Calculate XIRR in a Mutual Fund/ ULIP Fund?

It is essential to calculate XIRR in a mutual fund and ULIP fund for several reasons, some of which are as follows:

• To Get a More Accurate Measure of Your Returns: In the case of ULIP funds and mutual funds, you may invest in lump sums or through SIPs, which involve multiple cash flows happening at different times. XIRR takes into account the timing of all the cash flows, which gives you a more accurate measure of your returns.

• To Compare the Returns of Different Investments: If you compare the returns of two mutual funds or two ULIP funds, one with lump sum investment and the other with SIP investment, you cannot use CAGR to do this. This is because the two funds will have different cash flow patterns. XIRR can be used to compare the returns of various best investment options, regardless of their cash flow patterns.

• To Track the Performance of Your Investments Over Time: XIRR can be used to track the performance of your investments over time, even if you have made multiple withdrawals or investments. This can help you to make necessary adjustments to your investment strategy.

• To Make Better Investment Decisions: By understanding the XIRR of your investments, you can make better investment decisions. For example, if you are investing for a long period, you may be willing to accept a lower XIRR in exchange for lower risk.

How Does XIRR Work?

XIRR calculates the interest rate that, when applied to your investment over its duration, would yield the same final value as your actual investment. It does this by trial and error, testing different interest rates until it finds one that produces the desired ending value.

XIRR Formula:

XIRR = (NPV(Cash Flows, r) / Initial Investment) * 100

Where,

• NPV = Net present value of the cash flows

• R = Interest rate

• Initial Investment = Invested Amount

• Cash Flows = Amounts invested and withdrawn over the period of the investment

Illustration of XIRR Formula:

Suppose you make investments as per the following details:

• Deposit Amount on 01 January = Rs. 10,000

• Withdrawal Amount on 01 July = Rs. 2,000

• Balance Amount on 31 December = Rs. 11,000

The XIRR for this investment would be about 10%

Explanation: The XIRR value means that if you had invested Rs. 10,000 at the beginning of the year and compounded it at 10% interest, you would have ended up with Rs. 11,000 at the end of the year.

How to Calculate XIRR in Excel?

Follow the steps mentioned below to calculate the XIRR in a Mutual Fund or a ULIP Fund using MS Excel:

Step 1: Enter the cash flows in a column in Excel. The cash flows should be in chronological order, with the dates in the first column and the amounts in the second column.

Step 2: Select the cell where you want to display the XIRR.

Step 3: Type the following XIRR formula and press "Enter":

= XIRR (cash flows, dates)

 Where:

• Cash Flows: The range of cells that contain the cash flows

• Dates: The range of cells that contain the dates of the cash flows

Step 4: Excel will calculate the XIRR and display it in the selected cell.

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What are the Benefits of Calculating XIRR in a Mutual Fund/ ULIP Fund?

The key benefits of calculating XIRR in a mutual fund or a ULIP fund are listed below:

• Accuracy: XIRR is a more accurate measure of returns than CAGR because it considers the timing of all the cash flows. This is important for ULIP and mutual funds, where you typically make multiple investments over time.

• Consistency: XIRR is a consistent measure of returns, even if the cash flows are irregular. This is in contrast to CAGR, which can be misleading if the cash flows are irregular.

• Flexibility: XIRR can be used to calculate the returns of any investment, regardless of the cash flow pattern. This makes it a versatile tool for measuring investment performance.

• Transparency: XIRR is a transparent measure of returns, as it is based on the actual cash flows. This makes it easy for you to understand how your investments are performing.

• Relevance: XIRR is a relevant measure of returns for ULIP funds and mutual funds, as it considers the fees and expenses associated with these investments. This makes it a more accurate estimate of the actual returns that you can expect to earn.

XIRR Vs CAGR

The key differences between XIRR and CAGR are mentioned in the table below:

Wrapping It Up

XIRR (Extended Internal Rate of Return) is a valuable metric for evaluating the performance of ULIP and mutual funds. It provides you with a comprehensive view of your returns, accounting for the timing and amount of your investments. By considering both inflows and outflows, XIRR offers a more accurate representation of an investment fund's performance, helping you to make informed decisions about your investments.