Accurately measuring investment returns is key to understanding how well your money is growing. Whether you’re investing through lump sums or regular contributions like SIPs, choosing the right return metric helps you evaluate performance fairly and plan better.
Two commonly used methods are XIRR (Extended Internal Rate of Return) and CAGR (Compound Annual Growth Rate). While both provide annualised return figures, they work very differently and are suited to different investment styles.
There is often confusion between XIRR vs CAGR, especially among retail investors. Many use CAGR for all types of returns, which can lead to incorrect assumptions, particularly for SIPs or portfolios with multiple cash flows.
Understanding the difference helps you avoid errors and get a true picture of your investment’s growth. Read along to know more!
What is CAGR?
CAGR (Compound Annual Growth Rate) is the annualised rate at which an investment grows over a particular time. It assumes that profits are reinvested each year and provides a smoothed-out average return per year, even if actual returns vary annually.
HereтАЩs how you can easily calculate CAGR:
CAGR = (Final Value / Initial Value) ^ (1 / Number of Years) тАУ 1
When to Use CAGR
Use CAGR when you invest a lump sum amount and hold it for a fixed period without putting in or withdrawing any money. It’s useful when you need to compare long-term investment options like fixed deposits or one-time mutual fund investments.
LetтАЩs say you invested тВ╣1,00,000 in a mutual fund and it grew to тВ╣1,44,000 in 3 years. In this case, your CAGR would be:
CAGR = (1,44,000 / 1,00,000) ^ (1 / 3) тАУ 1 = 12.97%
However, CAGR vs XIRR for SIP is an important distinctionтАФCAGR does not consider multiple or irregular cash flows, which is why itтАЩs not suitable for SIPs.
What is XIRR?
XIRR (Extended Internal Rate of Return) is a method to calculate the return on investments with irregular cash flowsтАФsuch as SIPs (Systematic Investment Plans), withdrawals, or top-upsтАФeach happening on different dates.
How It Works
Unlike CAGR, XIRR factors in the exact date and amount of each transaction. It calculates a single annualised return rate that accounts for the timing and size of all cash inflows and outflows.
LetтАЩs say you invest тВ╣5,000 monthly in a mutual fund for 12 months and the final value after one year is тВ╣65,000. Each тВ╣5,000 entry happens on a different date.
XIRR uses all 12 investment dates and the final redemption date to calculate your true annualised return. This can’t be done accurately with CAGR.
Mutual fund platforms and financial planners widely use XIRR to evaluate SIP performance or portfolios with non-uniform investments.
XIRR vs CAGR тАУ Key Differences
Both XIRR (Extended Internal Rate of Return) and CAGR (Compound Annual Growth Rate) are methods used to calculate returns on investments. However, they differ in cash flow management and the type of investment they apply to. Here’s a clear comparison:
| Aspect | CAGR | XIRR |
| Type of Investment | Lump sum (single investment at the start) | SIPs, partial withdrawals, irregular cash flows |
| Cash Flow Pattern | Assumes only one investment and one redemption | Handles multiple and uneven cash inflows/outflows |
| Flexibility | Less flexible тАФ fixed timeline and investment | More flexible тАФ considers dates and amounts of each flow |
| Calculation Complexity | Simple to calculate manually | Complex тАФ generally requires a spreadsheet or a calculator |
| Usage Scenario | Long-term investments made once and held (e.g., FD, one-time mutual fund) | Recurring or staggered investments like SIPs or periodic top-ups |
Which One to Use тАУ CAGR or XIRR?
Choosing between CAGR and XIRR depends entirely on how your investment is structured.
- For SIPs: In Systematic Investment Plans (SIPs), you invest fixed amounts at regular intervals. Since each payment happens on a different date, XIRR accounts for the timing of every cash flow, making it the right metric to measure true returns.
- For lump sum: If you invest a single amount and leave it untouched for a few years, CAGR provides a clear picture of your average annual growth. It works well for fixed deposits, one-time mutual fund investments, or even stocks held long term without additional contributions.
For example:
- If you invested тВ╣1,00,000 in a mutual fund and left it untouched for 5 years, use CAGR.
- If you invest тВ╣5,000 every month through an SIP for 3 years, use XIRR to reflect your actual return.
- If you made irregular top-ups and redemptions in a mutual fund, again, XIRR gives a more precise result than CAGR.
Importance of Understanding Both Metrics
Knowing the difference between CAGR and XIRR is essential for making informed investment decisions. Each metric has a different purpose, and using the right one ensures you evaluate your investments accurately.
- Helps in evaluating mutual funds and portfolios: Use CAGR for lump sum investments and XIRR for SIPs or portfolios with multiple cash flows. This ensures you measure performance based on how the money was actually invested.
- Avoids misleading returns when using the wrong metric: Applying CAGR to an SIP can understate or overstate actual returns because it ignores the timing of each investment. Using XIRR in such cases gives a more realistic picture of performance.
- Better financial planning for investors: Understanding when to use CAGR vs XIRR helps you assess goals, compare funds properly, and plan more effectively. It gives you a clearer understanding of risk, return, and time commitment across different types of investments.
Conclusion
The key difference between XIRR and CAGR lies in how they handle investment patterns. CAGR is ideal for lump sum investments held over a fixed period, while XIRR is suited for SIPs and investments with multiple or irregular cash flows.
Understanding which metric to use (and when) helps you measure your returns more accurately. While CAGR gives a simple view of steady growth, XIRR reflects real-world investing more realistically, where cash flows vary over time.
As an investor, use both methods appropriately based on your investment style. This not only improves how you track performance but also supports better financial decisions going forward.
FAQs
What is the main difference between XIRR and CAGR?
The main difference is that CAGR assumes a single lump sum investment held over a fixed period, while XIRR accounts for multiple cash flows occurring at different times. XIRR is designed to handle complex investment patterns like SIPs, redemptions, and top-ups.
When should I use XIRR instead of CAGR?
Use XIRR when your investment involves multiple or irregular transactions, such as monthly SIPs, partial withdrawals, or varying investment amounts. It considers both the amount and timing of each cash flow, giving a more accurate return.
Is XIRR better than CAGR for SIP investments?
Yes. For SIPs, XIRR is more accurate because it reflects the actual return by factoring in each monthly investment and the date it was made. CAGR does not capture the timing of cash flows, making it unsuitable for SIPs.
Can I calculate CAGR for irregular investments?
Technically, yes, but it would not give an accurate result. CAGR assumes one investment and one redemption. If your investment has multiple entries or exits, the result may be misleading. Use XIRR in such cases.
Why do mutual fund apps show XIRR for SIPs?
Mutual fund apps display XIRR for SIPs because it accurately reflects the return on multiple contributions made over different dates. It considers both the amount and timing of each investment, giving a true picture of annualised growth.
Disclaimer
The information provided in this article is for educational and informational purposes only. It should not be considered as financial or investment advice. Investing in stocks involves risk, and it is important to conduct your research and consult with a qualified financial advisor before making any investment decisions. The author and publisher are not responsible for any financial losses or gains that may result from the use of this information.
