Have you ever wondered if your mutual fund investments are truly performing the way they seem? The aim behind any investment is usually to generate returns. However, for most investors, especially when their investments involve multiple cash flows with varying amounts, calculating and understanding returns can be quite difficult. This is where XIRR, or extended internal rate of return, plays an important role. It provides a clear, accurate measure of your investment’s performance.
Let’s break down what XIRR is, why it’s important, and how it can help you make smarter financial decisions.
What is XIRR?
XIRR is a financial metric used to calculate the annualised return of investments when cash flows are irregular. Unlike a simple return calculation, XIRR takes into account the timing of your investments and withdrawals, which makes it highly relevant for mutual fund investors who make regular investments through Systematic Investment Plans (SIPs) or withdraw at intervals through Systematic Withdrawal Plans (SWPs).
In simple terms, XIRR tells you the actual rate of return your money has earned by factoring in every rupee you have invested or withdrawn and when you did it.
How to calculate XIRR?
XIRR formula is: XIRR (values, dates, guess)
Where:
- Values represent the cash flows (money in and out).
- Dates are the corresponding transaction dates.
- The “Guess” is an optional parameter in Excel’s XIRR formula. If no value is entered, the default value of 0.1 is used.
To calculate XIRR in spreadsheet software like Microsoft Excel or Google Sheets:
- List all investments and withdrawals (cashflows) in one column (e.g., ₹ 10,000 for investments and ₹15,000 for redemption).
- Enter the respective dates in another column.
- Now, use the formula = XIRR (values, dates) to get the result.
All cash outflows (like SIP instalments or lump sum investments) should be recorded as negative values (with a minus sign before the amount). Similarly, all cash inflows (like redemptions) should be recorded as positive values.
To calculate XIRR, you can also use an online calculator or apps provided by many financial websites and investment platforms. Simply input all your cash flows along with their respective dates. The online tool processes your inputs using the XIRR formula and will display syour annualised return. These calculators are user-friendly and perfect for investors managing transactions like SIPs or SWPs without needing technical expertise.
Why is XIRR important for mutual funds?
Mutual fund schemes need the XIRR for the following reasons:
Near to precise assessments: XIRR considers all inflows and outflows, such as dividends, redemptions, and withdrawals, to deliver a more precise estimate of returns. It also factors in the timing and size of each cash flow.
SIP friendly: SIPs are widely preferred by mutual fund investors to invest in mutual fund plans and stay disciplined. In fact, in October alone, 63.7 lakh new SIPs were registered, which highlights their widespread adoption. XIRR is the most effective method to calculate SIP returns as it accounts for all SIPs made during the investment period and helps you evaluate your portfolio’s performance better.
Comparing different investments: With XIRR, you can compare multiple funds with different investment timelines or cash flow patterns. It standardises returns, which makes it easier to see which funds are performing better in your portfolio.
Note: XIRR majorly concentrates on cash flows, so make sure to account for any fees, charges, or loads associated with the investment.
Key takeaways
Understanding XIRR is crucial for any investor looking to evaluate mutual fund performance with precision. Unlike other metrics, it accounts for the timing and amount of every cash flow, be it investments, redemptions, or dividends. For SIP investors or those making irregular investments, XIRR is highly useful as it adjusts to the nature of such transactions.
By understanding and applying XIRR, you can make well-informed decisions, evaluate your portfolio better, and align your investments with your financial goals. So
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