Differences Between XIRR and CAGR: Meaning, Formula and Examples
When calculating investment returns, you may have come across CAGR and XIRR. Both metrics are useful, but they differ in how they calculate returns and in their application. Understanding the difference between CAGR and XIRR can help investors accurately assess the long-term growth and true returns of their investments, taking into account both steady and irregular cash flows for more informed decision-making.
In this blog, we will discuss the differences between CAGR and XIRR, explaining the strengths and weaknesses of each, and when one might be more useful than the other.
What is XIRR?
XIRR stands for Extended Internal Rate of Return. It calculates the rate of return on an investment, taking into account the timing of cash flows, including dividends and capital gains, over a specific period. This makes it useful for investments with irregular cash flows.
Let’s take an example,
Imagine you started investing on 1st January 2025, and continued each month. Your investment doesn’t grow at a constant rate. This is where XIRR calculation is applied. XIRR calculates the annualised rate of return based on the timing and amount of each cash flow. It looks at both inflows and outflows over time.
To understand XIRR, consider the Time Value of Money (TVM). TVM means money today is worth more than money in the future because you can invest it to earn returns. For example, if you invest ₹100 today at 5% interest, it will grow to ₹105 in a year. If given the choice between ₹100 now or ₹104 next year, ₹100 today is better because you can invest it and earn more.
XIRR accounts for the time value of money when calculating your returns. It helps assess mutual fund returns, lump sum investments, and SIP returns by considering the timing and amount of each investment.
What is CAGR?
Compound Annual Growth Rate (CAGR) is a key metric for evaluating investment returns. Unlike absolute return, which measures point-to-point returns without considering time, CAGR calculates the average annual return. It factors in the initial investment, final value, and the time elapsed.
CAGR is particularly useful when comparing returns over two dates: the date of the initial investment and the present day. It helps you understand how your investment has grown over that period.
For example,
Let’s say you invested ₹10,000 in stock A on 1st January 2025, and it’s now worth ₹17,492. To calculate absolute returns, use the formula:
Absolute Return = ( Current Value of investment / initial investment ) -1.
In this case, the absolute return is 74.92%. However, this doesn’t show how your investment grew each year. That’s where the calculating CAGR is useful.
CAGR tells you the average growth rate per year, assuming the investment grew steadily. For this example, the CAGR is 10.7%. This means the investment grew by about 10.7% each year on average.
Here’s the formula for CAGR:
CAGR = [(End Value / Start Value) ^ (365 / Number of Days)] – 1
In this case, the start value is ₹10,000, the end value is ₹17,492, and the time period is 2006 days(from 1st February 2020 to 30th July, 2025)
CAGR is useful for comparing different investments over the same time period, especially when there are no extra contributions or withdrawals during the investment period.
What is the Difference Between XIRR and CAGR?
The following table will analyze the difference between CAGR and XIRR:
| Basis | XIRR | CAGR |
|---|---|---|
| Meaning | XIRR calculates the rate of return based on both investments and cash flows. | CAGR calculates the rate of return based only on the starting and ending investment value. |
| Calculation | XIRR works with irregular cash flows, allowing for multiple investments and withdrawals | CAGR works with constant investments, where the same amount is invested regularly. |
| Timing | XIRR takes the timing of cash flows into account. | CAGR does not consider the timing of cash flows. |
| Inclusion of Cash Flows | XIRR requires all cash flows (both inflows and outflows) to be included. | CAGR requires only the initial and final investment amounts. |
| Investment Type | XIRR is Suitable for investments with multiple inflows and outflows, such as SIP or lump sum investments. | CAGR only works with investments where a fixed amount is invested regularly. |
| Rate of Return | XIRR considers the internal rate of return (IRR) based on actual cash flows and their timing. | CAGR considers the average annual growth rate of an investment over the period. |
| Complexity | XIRR calculation is more complex due to multiple cash flows and timing considerations. | CAGR calculation is simple, based on the start and end value of the investment. |
| Accuracy | XIRR is more accurate, as it takes both the timing and value of each cash flow into account. | CAGR is less accurate, as it doesn’t account for the timing of the investments or withdrawals. |
Key Difference Between XIRR and CAGR
CAGR (Compound Annual Growth Rate) measures the average annual growth of an investment over a specific period, assuming steady growth each year.
On the other hand, XIRR (Extended Internal Rate of Return) calculates the return on a series of cash flows occurring at irregular intervals, considering the time value of money. It provides a more accurate return measurement for investments with uneven cash flows
XIRR vs CAGR: What’s the Difference Between Their Calculation?n their Calculation?
CAGR is calculated by taking the average annual return over the investment period. It assumes the investment grows at a steady rate each year. XIRR, however, calculates the rate of return based on all cash flows, considering when money is invested and how it grows at different times.
The key difference is that CAGR only looks at the starting and ending values, while XIRR accounts for all cash flows throughout the investment period, making it more flexible for investments with varying amounts and timing.
Examples of CAGR and XIRR
CAGR and XIRR can give different results when calculating returns. Let’s see why with an example.
Suppose an investor invests ₹10,000 in a mutual fund on 1st January 2021. The fund pays ₹500 in dividends each year, and the investor reinvests them. By 31st December 2024, the fund is worth ₹14,000.
To calculate the CAGR, we use the formula:
CAGR = (Ending Value / Beginning Value)^(1/n) – 1
Where n is the number of years. Plugging in the values:
CAGR=(1000014000)(41)−1=0.1151 or 11.51%
Now, to calculate the XIRR, we need a table of cash flows, including the initial investment and the reinvested dividends. The cash flow table looks like this:
| Date | Cash Flow |
| 01/01/2022 | ₹(10,000) |
| 01/01/2023 | ₹(500) |
| 01/01/2024 | ₹(500) |
| 01/01/2025 | ₹(500) |
| 31/12/2025 | ₹14,000 |
Using an XIRR calculator, we get an XIRR of 12.33%.
In this example, CAGR only looks at the starting and ending values of the investment, while XIRR considers the timing and amount of each cash flow.
Limitations of CAGR
CAGR is useful for assessing investment performance, but it has some limitations.
- Assumes Constant Growth: CAGR assumes the investment grows at the same rate each year, which may not reflect real-world market changes or fluctuations.
- Not Suitable for All Risk Levels: CAGR does not account for the risk level of an investment. A high-risk investment may show a higher CAGR, but it doesn’t mean it is more stable.
Limitations of XIRR
While XIRR is a useful tool for calculating investment returns, it has some limitations:
- Accurate Cash Flow Data Required: XIRR depends on accurate and complete data, including the dates and amounts of each cash flow. Missing or incorrect data can affect the XIRR calculation’s accuracy
- Sensitivity to Small Data Changes: XIRR is sensitive to small changes in cash flow details. Even minor adjustments can impact the results, making it less reliable when comparing different investments based solely on XIRR returns.
- Not Universally Applicable: XIRR works well for investments with irregular cash flows, like high-volume trading stocks or real estate. However, it may not be suitable for investments with consistent cash flows, such as bonds or annuities.
XIRR vs CAGR: What are their Advantages and Disadvantages?
Advantages of XIRR
- Accounts for Uneven Cash Flows: XIRR considers the timing of cash flows, making it useful for investments with irregular payments, such as mutual fund SIPs.
- More Accurate Return Calculation: By factoring in both the timing and amount of cash flows, XIRR offers a more precise return calculation than other metrics.
Disadvantages of XIRR
- Complex to Calculate: Calculating XIRR can be challenging, especially for investments with many cash flows and changing returns..
- Limited Long-Term Insight: XIRR may not give a clear picture of long-term growth, as it focuses on annualised returns over the investment period.
Advantages of CAGR
- Simple to Calculate: The CAGR formula is straightforward and can easily be computed for lump sum investment returns.
- Clear View of Long-Term Performance: CAGR helps you understand the average annual return over a fixed period, making it useful for evaluating long-term investments.
Disadvantages of CAGR
- Ignores Cash Flow Timing: Unlike XIRR, CAGR assumes that cash flows happen evenly, which can mislead investors in cases of irregular payments.
- Can Be Misleading for Volatile Investments: CAGR may not accurately reflect the performance of an investment with high volatility, as it assumes a steady rate of return over the entire investment period.
XIRR vs CAGR for SIP Returns
Both CAGR and XIRR are useful for analysing SIP (Systematic Investment Plan) performance. However, XIRR for mutual funds is generally the better method for calculating SIP returns. SIPs involve regular, fixed investments, leading to irregular cash flows. XIRR accounts for the exact timing and amount of each cash flow, providing a more accurate measure of returns.
In contrast, CAGR assumes a constant rate of return across the investment period. This may not accurately reflect the returns from an SIP, as it doesn’t consider the varying timing of contributions.
How to Check CAGR and XIRR on smallcases?
Check out the images below to understand how you can analyse the CAGR vs XIRR on smallcases:
1. CAGR
2. XIRR
XIRR vs CAGR: Which Should You Use and When?
Situations where CAGR is more appropriate:
- When the investment has a fixed rate of return over time
- When the investment has a set holding period
- When there are no cash flows during the investment period
Examples of investments where CAGR is commonly used:
- Fixed deposits(FDs)
- Types of Bonds
- Mutual funds with a fixed holding period
- Real estate investments with fixed holding periods
Situations where XIRR is more appropriate:
- When the investment has irregular cash flows, such as in SIPs or mutual funds with frequent investments or withdrawals
- When the investment has varying rates of return over the investment period
- When the investment has no fixed holding period
Examples of investments where XIRR is commonly used:
- Systematic Investment Plans (SIPs) in mutual funds
- Investments with multiple cash inflows and outflows, such as in real estate
- Investments in venture capital and private equity funds, where cash flows are unpredictable and there is no fixed holding period
To Wrap It Up…
Both XIRR and CAGR are valuable tools for measuring investment returns, each with its own strengths. CAGR is straightforward and works well for long-term investments with a consistent rate of return. In contrast, XIRR is better suited for investments with irregular cash flows, as it accounts for both the timing and amount of cash inflows and outflows.
FAQs
XIRR is better for calculating SIP returns because it considers the timing and amount of each payment. CAGR assumes a steady return, which may not reflect the actual performance of SIP investments.
It depends on the type of investment. For investments with regular cash flows, such as lump sum investments, CAGR is a good enough measure of returns. However, for investments with irregular cash flows, such as SIPs, XIRR is a better measure of returns.
For short-term investments, absolute return is more effective. For longer durations, CGAR provides a clearer perspective. CAGR facilitates easy comparison of investments held for varying periods.
Yes, CAGR is also called annualised return. It evens out investment return fluctuations over time.
Generally, an XIRR above 12% signals strong performance for equity funds. For debt funds, anything exceeding 7.5% is considered favourable. However, it is advisable to consult a financial advisor to determine the ideal XIRR based on your risk tolerance.
It’s impossible to directly convert XIRR to CAGR, as XIRR accounts for irregular cash flows, while CAGR assumes steady growth. However, when there are no additional contributions or withdrawals, both metrics will yield the same result.
It’s impossible to directly convert XIRR to CAGR, as XIRR accounts for irregular cash flows, while CAGR assumes steady growth. However, when there are no additional contributions or withdrawals, both metrics will yield the same result.
XIRR is a better measure of returns from SIP than CAGR, because it takes into account the timing and amount of each investment, providing a more accurate reflection.
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