When it comes to investing in mutual funds, two important terms that you must be familiar with are CAGR and XIRR. These two terms are crucial when it comes to measuring the performance of your mutual fund investments. In this blog post, we will discuss what CAGR and XIRR are, and how you can calculate them.
CAGR or Compound Annual Growth Rate is a metric that measures the annual growth rate of an investment over a specific period of time. It is expressed in percentage and helps investors understand the average rate at which their investment has grown over the years. CAGR is a great way to compare the performance of different mutual funds over a similar period of time.
For example, if you invested Rs. 10,000 in a mutual fund and after five years, your investment grew to Rs. 18,000, then your CAGR for the five-year period would be:
CAGR = (Ending Value / Beginning Value) ^ (1 / Number of Years) – 1
CAGR = (18,000 / 10,000) ^ (1 / 5) – 1
CAGR = 12.47%
This means that your investment grew at an average annual rate of 12.47% over the five-year period.
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XIRR or Extended Internal Rate of Return is another metric that measures the performance of your mutual fund investments. XIRR takes into account the cash inflows and outflows of your investment over time. This means that it considers the timing and amount of your investments and redemptions. It is expressed in percentage and helps investors understand the overall return of their investments.
For example, let’s say you invested Rs. 10,000 in a mutual fund on 1st January 2018. After one year, on 1st January 2019, you invested an additional Rs. 5,000. On 1st January 2020, you redeemed Rs. 5,000 from your investment. Finally, on 1st January 2021, you redeemed the entire investment of Rs. 10,000. The XIRR for this investment would be:
XIRR = -10,000 + 5,000 / (1 + r) + 5,000 / (1 + r) ^2 + 10,000 / (1 + r) ^3
Where r is the XIRR that we are trying to calculate.
By using the IRR function in Excel, we can calculate the XIRR as:
XIRR = 14.74%
This means that your investment gave an overall return of 14.74% over the four-year period, taking into account the cash inflows and outflows.
Now that we know what CAGR and XIRR are and how to calculate them, let’s take a closer look at how we can use them to make informed investment decisions.
CAGR is useful when you want to compare the performance of different mutual funds over a specific period of time. For example, if you are considering two mutual funds that have been in operation for five years, you can compare their CAGR to determine which one has performed better over the years. However, it is important to note that CAGR does not take into account the timing and amount of your investments and redemptions.
On the other hand, XIRR is useful when you want to determine the overall return of your investment, taking into account the cash inflows and outflows over time. XIRR is particularly useful when you have made multiple investments and redemptions in a mutual fund over time. By calculating the XIRR, you can determine the actual return of your investment, rather than just the average return.
Conclusion:
Overall, understanding CAGR and XIRR can help investors make more informed investment decisions and assess the performance of their mutual fund investments. By utilizing these metrics, investors can gain a better understanding of the returns they are receiving and make more educated investment decisions in the future.
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