If you’ve ever tried to evaluate your mutual fund returns, you’ve likely come across two commonly used return metrics, i.e, CAGR (Compound Annual Growth Rate) and XIRR (Extended Internal Rate of Return). While both measure returns, they’re not interchangeable. Understanding the difference ensures you don’t misinterpret your actual performance.
In this article, we’ll clarify what is XIRR and CAGR, how each one works, their differences, and most importantly which one actually matters for SIP investors.
What is CAGR?
CAGR stands for Compound Annual Growth Rate, and it indicates how much an investment grew annually over a specific time period, assuming steady compounding. For investments held up to a year, absolute returns are enough to understand performance. But for anything held longer than a year, it’s more accurate to annualise the returns using CAGR.
CAGR is particularly valuable for comparing multiple investments across a common time frame, assuming the investment remains untouched with no interim inflows or outflows.
Example:
Suppose an investor puts ₹2,50,000 as a one-time lump sum into a mutual fund, and after 4 years the investment grows to ₹3,80,000. CAGR tells you the average yearly growth rate that consistently increases ₹2,50,000 to ₹3,80,000 over those 4 years.
It doesn’t care about the ups and downs during those 4 years, it only looks at the starting value and ending value and converts that into a smooth yearly growth rate.
What is XIRR?
XIRR stands for Extended Internal Rate of Return, and it measures returns when cash flows are irregular.It is used to calculate annualised returns when money goes in and out at different times. Unlike CAGR, which assumes a single lump-sum investment, XIRR considers the exact amount and date of each investment or withdrawal, making it suitable for SIPs, top-ups, partial redemptions, and other irregular cash flows.
If an investor does a SIP of ₹10,000 every month for 3 years, the total investment becomes ₹3,60,000. After 3 years, the investor redeems everything and gets ₹4,50,000. Since each ₹10,000 installment was invested on a different date and stayed invested for a different period, XIRR calculates the return by considering the timing and amount of every cash flow. This shows the investor’s actual yearly return, making XIRR the right way to evaluate SIP performance.
Difference Between CAGR and XIRR
Many investors get confused about XIRR vs CAGR and the easiest way to understand the distinction is by looking at how the cash flows behave.
Features | CAGR | XIRR |
Works Best For | One-time lump sum investments | SIPs, STPs, SWPs, top-ups, partial withdrawals, multiple redemptions |
Cash Flow Timing | Not considered; assumes money was invested once and sold once | Fully considered; every deposit/withdrawal date matters |
Formula | CAGR = (Final Value/Initial Value) (1/n)-1 | XIRR = (NPV (Cash Flows, r)/ Initial Investment)*100 |
How it Calculates | Uses only starting value, ending value, and period | Uses every cash flow (in & out) with exact dates |
To understand the comparison in a better way, check out this video – CAGR vs XIRR
CAGR vs XIRR: Which is better for SIP?
CAGR is straightforward and works well for long-term investments where a single lump sum grows at a relatively consistent rate. It shows the average annual growth, making it ideal for comparing different funds or evaluating long-term returns from one-time investments. In contrast, XIRR is better suited for investments with irregular cash flows, such as SIPs, top-ups, or partial withdrawals, because it takes into account both the timing and amount of each contribution or redemption.
For SIP investors, XIRR is the preferred metric, as it reflects the actual returns earned on your portfolio rather than just the fund’s overall growth. While CAGR gives a simplified view of growth, XIRR provides a more realistic picture of your personal investment performance.
Frequently Asked Questions (FAQ)
Which return metric should SIP investors use: CAGR or XIRR?
SIP investors should primarily use XIRR because SIPs involve multiple investments made on different dates. XIRR considers the timing and amount of each cash flow, giving a more accurate picture of your actual portfolio returns.
When is CAGR the right metric to use?
CAGR is best for one-time lump sum investments where you invest once and redeem once after a certain period. It uses only the beginning value, ending value, and time duration to show the average annual growth rate.
If I do SIP top-ups or partial withdrawals, should I still use CAGR?
No. If your investments include top-ups, partial redemptions, multiple purchases, or withdrawals, your cash flows become irregular. In such cases, XIRR is the correct metric because it factors in every transaction date and amount.
Why is my portfolio XIRR different from the fund’s CAGR?
A fund’s CAGR reflects the fund’s overall growth over a period. Your XIRR reflects your personal investment journey, including the exact dates you invested and redeemed. Since your money wasn’t invested on day one as a lump sum, the numbers often differ.
Does a lower XIRR always mean my SIP is underperforming?
Not necessarily. XIRR can look lower temporarily due to recent market volatility, the fact that newer SIP installments have had less time to grow, or if you made withdrawals. It’s best to evaluate XIRR over a longer period and alongside your goal timeline.
