Mutual funds remain an important investment tool for generating wealth over a period. In any mutual funds investment, tracking of returns is essential. This can be undertaken using compound annual growth rate (CAGR) and extended internal rate of return (XIRR).
Here’s the lowdown on understanding how mutual funds investments can be suitably tracked using CAGR and XIRR.
CAGR highlights the annual growth rate of an investment over a particular period.
The formula to calculate CAGR is: CAGR=(EV/BV)^ (1/n)-1
In this, EV refers to the ending value of the investment, while BV relates to the beginning value of the investment, and n signifies the number of years the investment spans.
At the same time, XIRR is a comparatively complex metric that takes into account the timings of the investment. However, it provides a more accurate return rate.
In the case of a systematic investment plan (SIP), where an investor makes periodic investments, the timing of these investments tends to have an influence on the returns of the portfolio.
In this regard, XIRR comes across as a more accurate metric when it comes to assessing returns and assessing performance.
The formula for calculating XIRR is: XIRR(values, dates, [guess])
In this case, values relate to the amount an investor has invested. This investment amount is to be mentioned in negative, considering it is an outflow.
Dates relate to dates of investment and redemption in case any, while guess relates to an optional guess of the IRR, which is generally left blank.
Normally, an XIRR of about 12% is considered good for equity mutual funds, while in the case of debt funds, it stands at 7.5%.
Typically, CAGR is used in the case of calculating the returns of a lump sum investment, while XIRR is useful in the case of investment in SIP mode.
Rajiv is an independent editorial consultant for the last decade. Prior to this, he worked as a full-time journalist associated with various prominent print media houses. In his spare time, he loves to paint on canvas.