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Sound investments breed profitable returns. Therefore, evaluating your return on investment (ROI) is critical, even when putting your money in the best long-term mutual funds. That said, the next important factor is to learn how to measure these returns accurately. ROI measurement entails calculating important metrics, especially XIRR (Extended Internal Rate of Return) and CAGR (Compound Annual Growth Rate). Both methods evaluate returns; however, each serves a unique purpose and is suitable for varying investment scenarios. This blog will help break down XIRR vs. CAGR so you can make informed investment decisions.
CAGR is the simple, clean average. CAGR tells you how much an investment has grown annually, assuming a steady, uninterrupted rate. It’s perfect for evaluating single investments over a fixed period.
Formula: CAGR = [(Final Value / Initial Value)^(1/n)] - 1
You don’t need to do the math manually—Excel or Google Sheets can handle it for you:
Imagine you invested ₹10,000 in a mutual fund five years ago. Today, the value is ₹20,000. The CAGR would be:
CAGR tells you that your investment grew at an annual rate of 14.87% over five years.
Real investments aren’t always so neat. You add money, withdraw funds, and reinvest dividends. That’s where XIRR comes in—it accounts for multiple cash flows and calculates the actual return based on when money moves in and out.
You can easily calculate CAGR in Excel or Google Sheets using the following formula:
=XIRR(cash flows, dates)
Let’s say you invest Rs 10,000, then add Rs 5,000 after a year, and withdraw Rs 3,000 later. CAGR won’t reflect this, but XIRR will. That’s why XIRR is the go-to metric for portfolios with irregular cash flows—real life, in other words.
Or
If you invest ₹10,000 every month for 12 months in a mutual fund and the fund’s value after a year is ₹130,000, XIRR takes into account the timing of each monthly investment and calculates the annualized return.
When investors look for the best long-term mutual funds, they should understand the importance of XIRR and CAGR. Following are a few points that highlight how metrics like XIRR and CAGR help investors evaluate their returns:
When you are unaware of your portfolio performance, then future investment decisions won't be well-informed. Therefore, evaluating investment performance is mandatory, especially when choosing the best long-term mutual funds. Here's how you can use XIRR and CAGR effectively to evaluate your returns:
There are no one-size-fits-all metrics available to measure different investment types. For example, a one-time investment calls for CAGR as your go-to metric. It provides a straightforward measure of your annualized returns over a specific period. On the other hand, SIPs made at multiple intervals require an XIRR metric, as it factors in the timing and amount of each cash flow.
During the evaluation of mutual funds, you can choose one singular metric, either XIRR or CAGR, for a fair comparison. An inconsistent metric can lead to incorrect conclusions about which fund offers better returns. For instance, XIRR is more relevant for SIPs, while CAGR is ideal for lump-sum investments.
Manual calculations lead to potential errors that can be avoided by leveraging automated tools. Platforms like Cube Wealth offer ROI calculators to compute XIRR and CAGR effortlessly. These tools can simplify complex formulas to save you enough time and provide a precise return on investment value.
Both XIRR and CAGR yield meaningful insights over longer periods. They are valuable for assessing the best long-term mutual funds. During the evaluation of SIP investments or lump-sum mutual funds, a longer time horizon is needed to smooth market fluctuations and provide a clearer picture of performance.
At Cube Wealth, we understand that financial jargon like XIRR and CAGR can be overwhelming. That’s why we simplify your investment journey:
Understanding the difference between XIRR and CAGR is crucial for evaluating the performance of your mutual fund investments. Both metrics serve specific purposes: CAGR simplifies lump-sum analysis, while XIRR provides accurate returns for SIPs. When investing in the best long-term mutual funds, leveraging the right metric ensures that you maximize your return on investment and make data-driven financial decisions.
At Cube Wealth, we’re committed to helping you achieve financial success. Whether you’re investing via SIP or lump sum, our platform empowers you with accurate insights and expert guidance to grow your wealth effortlessly. Get in touch with our Wealth Coach and start your journey today and discover how easy investing in mutual funds can be!
1. Why is XIRR used to calculate returns from SIP and not CAGR?
XIRR is used for SIPs because the principal invested keeps changing in a SIP, as you keep adding to your investments every month or week. In such cases, XIRR accurately accounts for several cash flows at regular or irregular intervals, which is characteristic of SIPs (Systematic Investment Plans), unlike CAGR.
2. Which is better, XIRR vs CAGR?
Honestly, both have their pros and cons. CAGR is inefficient when there is a change in the amount invested in between the periods, for example, an SIP or even if you keep investing and withdrawing ad-hoc in a mutual fund.
3. Which is better: CAGR or absolute return?
The choice depends on what you are looking to measure. Absolute returns do not take into consideration the period of investment. You should use absolute return when comparing short-term investments or when you simply want to know the total gain.
CAGR smooths out the growth rate over a period, showing how much your investment grew annually, assuming a steady rate.
4. What XIRR is good?
This is a question that I frequently face from our users: is XIRR of 12% good or is 20% XIRR good? Honestly, It is difficult to answer this question. However, here are a few pointers that I use.
But most importantly, returns are just one factor in evaluating your fund or portfolio’s performance. At Cube Wealth, we use more than 20 factors to evaluate a mutual fund. For example, what is the alpha (outperformance) of the fund, what is the period over which you are evaluating the performance, and how much risk did the fund take to deliver this return?
Speak to our Wealth Coach to get personalized advice!
5. Are annualized returns and CAGR the same?
Annualized returns and Compound Annual Growth Rate (CAGR) are closely related, but they're not the same thing.
Annualized returns represent the average return an investment has generated per year over a specific period. It smooths out the highs and lows, so you're essentially looking at what the return would have been if the investment performed at that rate every year.
CAGR, on the other hand, is a more precise calculation. It measures the consistent, compounded rate of return that would have turned an initial investment into its final value over a set period. Unlike annualized returns, CAGR assumes that all gains are reinvested and grow at a constant rate year over year, regardless of any fluctuations in between.
In simpler terms, while both deal with the yearly return, CAGR is a more accurate representation of an investment's growth over time because it accounts for the compounding effect. Annualized returns can sometimes be influenced by volatility or one-time events during the investment period.
6. Can we convert XIRR to CAGR?
To convert XIRR to CAGR, you essentially calculate the average annual growth rate assuming no further cash flows are made beyond the initial and final amounts, effectively “smoothing out” the variations in cash flows.
Let’s say you made an investment of ₹1,00,000 (initial value) in a mutual fund, and after 3 years, the value of your investment grew to ₹1,60,000. Assume that the XIRR of this investment, calculated based on irregular cash flows, was 15% annually.
To convert XIRR to CAGR, we can directly use the CAGR formula (since the cash flows are assumed to be similar to the constant annual growth implied by CAGR).
Now, using the CAGR formula:
So, in this example, the CAGR is approximately 16.9% per annum, which is a close match to the XIRR of 15% (considering that the cash flows in reality would have been irregular).
7. Are CAGR and XIRR the same?
No, CAGR (Compound Annual Growth Rate) and XIRR (Extended Internal Rate of Return) are related but not the same. CAGR measures the average annual growth rate of an investment assuming a consistent growth rate over a period. It’s useful for steady investments. XIRR, on the other hand, accounts for irregular cash flows and provides a rate of return that balances those varying inflows and outflows over time. For example, if you invest ₹1,00,000 and withdraw ₹10,000 at irregular intervals, XIRR reflects that complexity, while CAGR assumes the investment grows at a constant rate.
8. What is the difference between CAGR and the absolute return formula?
Think of CAGR as the smooth, steady growth of your money over time. It tells you what your average yearly return would be if your investment grew at the same rate every year. For example, if you invested ₹10,000 and after 5 years it became ₹20,000, CAGR would tell you the constant yearly growth that led to that result.
On the other hand, absolute return just tells you how much your money grew in total. If your ₹10,000 turned into ₹20,000, the absolute return is ₹10,000, with no focus on how the money grew year by year.
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