Mutual fund SIP investments: Mutual funds and Systematic Investment Plans (SIPs) usually offer a promising path to wealth growth. However, new investors looking to put their money in these instruments may find tracking returns a daunting task. This is where the concepts of Extended Internal Rate of Return (XIRR) and Compound Annual Growth Rate (CAGR) come into play.
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Times Now approached an expert to decode these essential tools for easy understanding.
What Is CAGR In Mutual Funds
CAGR tells you the annual growth rate of your investment over a specific period. Imagine you have a plant that has been growing for five years now. Its CAGR would show you how much its average yearly growth has been.
Nehal Mota, Co-Founder & CEO, Finnovate, a hybrid financial fitness platform, explained the formula to calculate CAGR:
CAGR = ((EV/BV)^(1/n)) – 1
Where “EV” refers to the ending value of your investment, “BV” refers to the beginning value of your investment, and ‘n’ is the number of years the investment has lasted.
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“For example, if you invest Rs 5,000 in a mutual fund and the CAGR is 10 per cent over five years, it means that your investment would have increased 10 per cent every year. However, the actual growth may vary for different years. In the first year, it may be 13 per cent, in the second year, it may be 7 per cent and so on,” she said, adding that “CAGR gives you a consistent growth rate that can be used for comparison across different funds.”
How Is XIRR different from CAGR?
XIRR is a more complex metric that takes into consideration the timing of these investments and provides a more accurate return rate. For a Systematic Investment Plan (SIP), where you periodically make investments, the timing of your investments also affects the returns of your portfolio. In such cases, XIRR is a more accurate metric to calculate your returns and assess your performance.
Nehal Mota said that an investor can calculate XIRR in MS Excel using the XIRR function:
=XIRR(Values, Dates, [guess])
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Here, “Values” refers to the amount you have invested. Note that the investment amount should be written in negative since it is an outflow. “Dates” are the dates of investment (and redemption, if at all), while “Guess” refers to an optional guess of the IRR which is mostly left blank.
While CAGR is used to calculate the returns of a lump sum investment, XIRR is useful for an SIP.
