CAGR Vs XIRR: Which One is Better

When evaluating the performance of mutual funds, investors often come across metrics like CAGR and XIRR in mutual funds. While both help in understanding investment returns, they apply in different contexts and are used for various types of investment scenarios.

This article will clarify the meaning of XIRR and CAGR, highlight their differences, and help you decide which metric suits your needs best.

Meaning of CAGR

Compound Annual Growth Rate (CAGR) is a valuable metric that calculates the average annual return of an investment across a defined timeframe. It shows how much an investment grows each year on average, based on the assumption that returns are reinvested and compounded annually.

This metric is particularly useful for assessing investments that grow steadily over time, such as mutual funds or stocks. CAGR offers a consistent and standardized way to compare the returns of different investments. It is determined based on the starting value, ending value, and the overall time span of the investment.

CAGR Example: Formula & Calculation

Formula:

CAGR = (Ending Value / Starting Value)^(1 / Number of Years) – 1

Example:

You invest ₹80,000 in a mutual fund on April 1, 2017. By April 1, 2022, it grows to ₹1,05,000.

• Starting Value: ₹80,000
• Ending Value: ₹1,05,000
• Duration: 5 years
  
  CAGR = (1,05,000 / 80,000)^(1/5) – 1 = 5.72%

This means your investment grew at an average annual rate of 5.72%, assuming steady compounding.

Meaning of XIRR

XIRR, which stands for Extended Internal Rate of Return, is a widely used method for evaluating how well an investment performs, especially with varying cash flows. It takes into account both the timing and the amount of cash flows during the investment period. XIRR computes the return rate at which the net present value of all cash inflows and outflows becomes zero.

Unlike simpler metrics such as CAGR, XIRR is designed to handle irregular cash flows occurring at different times, making it ideal for evaluating investments with varied transaction patterns.

XIRR Example: Formula & Calculation

XIRR accounts for irregular cash flows and uses Excel’s iterative method.

Excel Formula:

=XIRR(values, dates, [guess])

• Values: Cash flows (investments as negatives, returns as positives)
• Dates: Exact transaction dates
• Guess: Optional estimated return (usually skipped)

Example:

• ₹70,000 invested on Jan 15, 2022
• ₹30,000 added on Jun 15, 2022
• ₹1,15,000 received on Dec 31, 2022

Values: -70,000, -30,000, 1,15,000

Dates: 15/01/2022, 15/06/2022, 31/12/2022

Using =XIRR(values, dates) in Excel gives your annualized return, accurately reflecting the timing of each cash flow.

Comprehensive Comparison Between CAGR and XIRR

When evaluating investment performance, especially in mutual funds, comparing CAGR vs XIRR becomes essential to choose the most accurate metric based on your investment style.

Note: If you’re looking to invest in top-rated mutual funds, using XIRR can help you compare the performance of funds, especially when you're contributing at different times. This ensures a more informed and accurate evaluation of potential returns.

Advantages and Limitations of CAGR and XIRR

CAGR or XIRR: Which One is Better for You?

The decision to use CAGR or XIRR primarily depends on the structure of your investment. If your investment is a one-time lump sum, CAGR gives a quick and simple snapshot of its annual growth. It’s ideal for straightforward investments where there are no additional contributions or withdrawals.

On the other hand, XIRR is the better metric if your investment involves multiple transactions at different points in time, like SIPs, top-ups, or partial redemptions. It considers both the timing and amount of each transaction, providing a more precise representation of your portfolio’s true performance.

So, if your investment journey is linear and consistent, CAGR works well. But if it includes multiple inflows and outflows, XIRR gives you a truer picture of returns.

When and Where to Use CAGR and XIRR?

Use CAGR When:

• You invested a lump sum at the beginning and held it without adding or withdrawing money.
• You want to compare the historical returns of mutual funds or stocks over a fixed period.
• You're evaluating performance based on start and end values only.

Use XIRR When:

• You've made several investments over time, such as through SIPs.
• Your portfolio includes irregular transactions, top-ups, withdrawals, or partial redemptions.
• You want to calculate annualized returns that factor in both the amount and timing of each investment.

Final Thoughts

Both metrics, CAGR and XIRR, have their rightful place. The goal isn’t to choose the most flattering figure, but the most accurate and relevant one for your investment pattern. By aligning the metric to your strategy, you’ll get a clearer picture of performance and make smarter investment decisions.

Frequently Asked Questions (FAQs)

Which is more accurate: CAGR vs XIRR?

XIRR is generally more accurate than CAGR, especially when there are multiple investments made at different times (e.g., SIPs). While CAGR assumes a single lump sum investment with consistent compounding, XIRR reflects real-world cash flow timing and provides a more precise return rate.

Which is better? Absolute Return vs XIRR?

XIRR is typically more suitable for investments involving multiple transactions, like SIPs, as it factors in both the dates and amounts of each cash flow. Absolute Return, while easier to calculate, does not consider how long the money was invested and can be misleading for long-term or staggered investments.

Can XIRR be negative?

XIRR may turn out negative when the total withdrawals or cash outflows surpass the incoming funds or gains. This indicates a net loss over the investment period, accounting for the timing of each transaction.

How is XIRR different from IRR?

The key distinction between XIRR vs IRR is in their handling of cash flow dates. IRR assumes that all cash flows occur at regular intervals, while XIRR allows for cash flows on specific dates, making it suitable for real-life investment scenarios with irregular transactions.

Can I convert XIRR to CAGR or vice versa?

There’s no direct formula to convert XIRR to CAGR because they are based on different assumptions. However, if the cash flows are made only once at the beginning and the return is received at the end, XIRR and CAGR will yield similar results. For multiple cash flows, they can differ significantly and are not interchangeable.