What Is XIRR In Mutual Funds – Meaning, Full Form and Formula

Just picture this: You invest 10,000 monthly through an SIP into a mutual fund. Do you just add 10,000 up each month for a year? Do you not consider any other factors of returns? Assuming you also consider some factors of returns, such as a return rate, how much would you consider? Maybe you consider 12%. In the case of mutual funds, doesn’t the return rate vary according to market conditions? Of course, it does. There needs to be a solution for this, right? The solution could be XIRR. What is XIRR in mutual funds? Keep reading to find all your answers.

Understanding the performance metrics while investing in mutual funds helps in judging how much return your investment would yield. One such measure is the XIRR (Extended Internal Rate of Return), which provides an exact return value, especially in investments where the transactions occur in several instances over a period.

XIRR Overview in Mutual Funds

XIRR represents a financial metric that evaluates the annualized return over investments with multiple cash inflows and outflows coming at different times. Compared to other methods, such as lump sum investment models, XIRR takes account of the time and sum of each investment and redemption. This is very convenient as mutual fund XIRR for SIPs, SWPs, and other forms of staggered investments.

What is XIRR in Mutual Funds?

XIRR helps investors know the actual rate of return on investments by considering the following:

• The dates of every cash flow (investment or redemption).
• The amounts involved in each transaction.
• The final value of the portfolio.

XIRR takes into consideration the time value of money, thus providing a correct and realistic measure of how investments have performed over time, especially when cash flows are irregular.

The formula of XIRR in Mutual Funds and Its Limitations

The mutual fund XIRR formula is an extension of the IRR, or Internal Rate of Return, calculated through trial and error in order to arrive at a rate at which the sum of all the cash flows in terms of NPV becomes zero as follows:

NPV = ∑ (Cash Flow / (1 + XIRR)^t) = 0

Where,
Cash Flow is the amount of every transaction, be it an investment or redemption.
t is the time in years from the starting date of the first cash flow.

Limitations of XIRR:

• Assumption of Reinvestment: XIRR assumes that intermediate cash flows are reinvested at the same rate, which might not be the case in reality.
• Complexity: XIRR calculations might need to be clarified for those investors who need help understanding financial concepts.
• Sensitivity to Data Accuracy: Results are highly affected if the dates or the amounts are wrong.

Knowing the Precision of XIRR by an Example

Let’s take an example:

You invested ₹50,000 in a mutual fund on January 1, 2021.

You invest another ₹50,000 on July 1, 2021.

You redeem the total amount of ₹120,000 on January 1, 2022.

Using the mutual fund XIRR formula, you can compute the annualized return considering the exact dates and amounts of investments and redemptions. This is more accurate than using simple annualized return metrics that ignore the timing of cash flows.

Calculating XIRR

XIRR can usually be calculated using financial software or tools such as MS Excel.

It involves:

• Writing down all cash flows. Investments are negative, while redemptions are positive.
• Adding the corresponding date of each transaction.
• Utilizing the XIRR formula in MS Excel or its equivalent to calculate the annualized return.
• Step-by-Step Guide to Calculating XIRR in MS Excel
• Input Data: Prepare two columns of Excel: one for amounts and another for dates associated with the transaction.

Following is the example:

XIRR Function: Select a formula =XIRR(values, dates).

Replace values with the range of your amounts.
Replace dates with the range of your respective dates.
Result: Key in Enter to get XIRR value that reflects annually the return on your investment.

Conclusion

XIRR is widely used to evaluate the performance of mutual fund investments where periodic cash flows occur frequently or irregularly. Accounting for both timing and cash flow amounts enables investors to determine realistic measurements of their investment results. Knowing about XIRR gives investors better grounds upon which to base informed investment and financial decisions.

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