XIRR vs CAGR vs Absolute Return – Terms To Measure Mutual Funds Returns
We at “b4investing” help our readers in assessing mutual fund performance by checking their returns. This helps you as an investor to monitor how much a particular mutual fund has gained or lost during a specific investment period. Let’s understand the terms like Absolute Return, CAGR or XIRR used in Mutual Fund; the difference between them and their relevance to the mutual fund portfolio.
ABSOLUTE RETURN in MUTUAL FUND
Absolute Return or Total Return help in calculating how much gain or loss have been made on the investment. It is the simplest measure of calculating returns. Absolute return in mutual fund is return from a fund over a certain period of time. It is the total return from a mutual fund from the date of investment.
Absolute Return is used to showcase a simple point-to-point return where holding time is less than a year.
How to calculate absolute return
To calculate, we need to know the initial and the current or the ending value of the investment scheme.
Suppose Mr.V invests Rs. 1,00,000. And after ten months, his investment matures to Rs. 1,00,000. His absolute returns will be:
| Absolute Returns = (Ending Value – Initial Value) / Initial Value * 100 = (1,20,000 – 1,00,000 / 1,00,000) * 100 = 20% |
Thus, Mr.V has made an absolute return of 20% over a 10-month period.
Also Read: Is it safe to invest in Mutual Fund?
COMPOUNDED ANNUAL GROWTH RATE (CAGR) in MUTUAL FUND
Compounded annual growth rate (CAGR) is one of the most commonly used terms in the mutual fund industry. CAGR or Compound Annual Growth Rate helps to gauge the average yearly growth of the investments over a specific time period. It contains the assumption that investment is compounded over time.
CAGR is a relevant ratio to assess a lumpsum investment. Use these returns to evaluate how the mutual fund investment is performing among parity schemes, against benchmark or other avenues such as bank deposits.
It just requires three inputs; an investment’s beginning value, ending value and the period.
The formula to calculate CAGR is:
| CAGR (%) = (Ending investment value / Beginning Investment Amount) ^ (1/investment tenure in years) – 1 |
How to calculate CAGR
- At first add the initial amount investment or the beginning investment value.
- Enter the current or ending investment value.
- Now, use the CAGR formula.
Suppose Mr. V have invested Rs.1,00,000 in scheme A for 3 years and he wants to compare with another scheme B for a lesser investment period of 2 years. So here, absolute returns may not give a whole picture since the period is different. Hence, it would help if he used CAGR.
| Scheme A | Scheme B | |
| Beginning Investment Amount | Rs.1,00,000 | Rs.1,00,00 |
| Investment Tenure | 3 years | 2 years |
| Ending Investment Value | Rs. 1,40,000 | Rs. 1,30,000 |
| CAGR(%) | 11.87% | 14.02% |
After comparing both the options, you can see that scheme B is earning better returns than Scheme A. While the absolute returns on Scheme A is higher than the second one, however, the earning potential for the second option is greater as determined by the CAGR.
Limitations with CAGR:
- CAGR assumes a steady growth rate over the investment tenure.
- It ignores market movements which is the basic nature of the mutual fund investment.3
- It does not consider the interim period.
- It does not take periodic investment into picture.
- Irrelevant for SIP investments.
This is where IRR (Internal Rate of Return) or XIRR (Extended Internal Rate of Return) comes into the picture.
EXTENDED INTERNAL RATE OF RETURN (XIRR) in MUTUAL FUND
XIRR stands for Extended Internal Rate of Return, a method used to calculate returns on investments. XIRR meaning in mutual fund is to calculate ROI where there are multiple transactions taking place in different times. XIRR is that single rate of return, which would give the current value of investment when applied to every installment (and redemptions if any). XIRR is your personal rate of return. It is your actual return on investments.
In real life, the investments & redemptions happen over a different period, and in such a scenario, CAGR may not be applicable to calculate the returns. If investing through SIP, XIRR is the appropriate way to measure returns.
Think of XIRR as nothing but an aggregation of multiple CAGRs. If an investor makes multiple investments in a fund, then use the XIRR formula to calculate overall CAGR for all those investments taken together.
| XIRR can be easily calculated using Microsoft Excel. Excel provides an inbuilt function to calculate XIRR. XIRR formula in excel is:= XIRR (value, dates, guess) |
How to calculate XIRR
- In the first column, add the date of investment transactions.
- In the next column, entre all investment transactions.
- All outflows like investments and purchases will be marked negative, while all inflows like withdrawals and redemptions are marked positive.
- In the last row, mention the current value of the holdings and the date of redemptions.
- Now, use the XIRR function in excel, which is =XIRR (investment amount, date).
Let us understand with an example. Suppose you made a SIP of Rs.10,000 every month for eight months into Scheme A starting from April 01, 2020 to Nov 01, 2020. And you wish to redeem on Nov 24, 2020. Assuming NAV on the date of redemption is Rs.39.48.
Thus, the value of your investment = Total No. of units X NAV at the date of redemption = 2508.02 X 39.48 = Rs.99,017.
Difference between Absolute Return, CAGR & XIRR | XIRR vs CAGR vs Absolute Return
| Approach using Absolute Return | Approach using CAGR | Approach using XIRR |
| (Final Value – Initial Value) / Initial Value * 100 | Time period = 8 months = 6/12 = 0.67 years | XIRR = XIRR (value, dates, guess) |
| (₹99,017 – ₹80,000)/ ₹80,000 | (99017 / 80000) ^ (1/0.67) -1 | |
| = 23.17% | = 37.67% | 79% |
| Particulars | Absolute Returns | CAGR | XIRR |
| Description | It is a measure of how much gain or loss you have made on your investment. | It is a measure of compound rate of growth. | It is the average rate earned by each and every cash flow invested during the period. |
| Usage | It shows the exact return delivered by the fund in the past 1 year. | Compare different funds or investment product. | Evaluate personal rate of return. It is your actual return on investment. |
| Investment | All the return figures marked under ‘year-on-year returns’ are Absolute Returns. | CAGR is appropriate to calculate lumpsum investment. | XIRR is used when the investment is spread over a period of time. |
The Bottom Line:
We read what is the meaning of absolute return, XIRR, CAGR in mutual fund. We also read how to calculate mutual fund return using absolute return, CAGR and XIRR formula. An investor should always assess his investment in terms of his returns. The market fluctuation is a key factor in assessing the return which should be taken into consideration. The three methods mentioned above have their own fancy and flaw, but the choice depends on the investor as well as the kind of investment he has done and on the kind of return he is willing to assess at a particular point of time.
Be Educated!
Be Bold!!
But, Be Careful!!!
Happy Investing!!!
