XIRR – What it means for Mutual Funds
Many of the investors from the Mutual Fund may have found the term XIRR. But it's difficult to digest what it is for most of them. Therefore, let's simplify it.
What is XIRR
XIRR or extended internal return rate is a return metric used when various investments are made in a financial instrument (at distinct times).
A majority of mutual fund investments are made via Systematic Investment Plan (SIP). A SIP is a way to invest regular amounts across periods in a scheme. So, numerous investments over distinct periods can make your return calculation very ambiguous as more investment variations create more variations in purchase cost.
XIRR comes into the scene here. XIRR provides you with the present value of your investment in Mutual Funds. XIRR is an accurately calculated rate that provides you a particular assessment when applied to your every investment. It plays a very important role in the calculation of yields for Mutual Funds, even if it is not always done in SIP. XIRR also operates in lump sum investments, as this is your portfolio assessment, unlike any other calculation instruments.
Therefore, XIRR is nothing but various CAGR aggregation.
Importance of XIRR in mutual funds
Perfect regular investment is ideal, but investment, in the long run, is often found to be irregular and even the cash flow differs in and out of the scheme. Early withdrawals from a scheme or late deposits sometimes occur or months are skipped in a row at times. You can't depend on simple interest rate return in that situation. Factors like the quantities invested and the corresponding times of their investments are what we need to pay attention to. With each investment, the time and quantity can determine the output differently. This is where XIRR helps you by taking into account all the differences and presenting your chosen mutual funds with a consolidated return.
How to Calculate XIRR
Unlike other return metrics like CAGR which can be calculated easily through a calculator, XIRR needs to be calculated on an Excel sheet. Let's take an instance of spending Rs.5,000 for 6 months each month (on the 5th of each month). In the middle, you are investing a lump sum of Rs.25,000 on 16 August 2018. You cancel the entire investment on the fifth date of the seventh month. Let’s clarify the same with the dates below:
- First SIP on June 5th, 2018.
- Second SIP, July 5, 2018.
- SIP 3rd on August 5, 2018.
- Investment in Lump Sum on September 16, 2018.
- On September 5, 2018, fourth SIP.
- SIP Fifth on October 5, 2018.
- On November 5, 2018, sixth and final SIP.
- On December 5, 2018, you withdraw all the cash.
The above information must be entered into the Excel sheet. But take care of the below points before jumping into data entry.
- Enter in one column all transactions.
- All outflows such as investments are treated as a NEGATIVE value and all inflows such as withdrawals are treated as a POSITIVE value.
- Add all transaction dates to the next column.
XIRR formula in excel is the direct formula for calculating the XIRR. That is, XIRR (value, dates, guess) *100.
Here, VALUE indicates the quantity of cash flow to be selected, dates indicate the dates of the transaction and leave the field of guess blank. You can either enter this formula in the cell where you want the outcome, or you can choose it from Excel's "Formula" menu.
If you choose the Mutual Funds growth scheme and schedule your SIPs at periodic intervals, you can choose the IRR (Internal Rate of Return) technique for evaluating your yields. However, it may be a bit hard to execute. In Mutual Fund investments, we don't always pursue the 'purchase and hold approach.' As our savings witness debts and credits on and off our mutual fund transactions, we have no other way but to apply XIRR to calculate our investment returns.