A Systematic Investment Plan has become a common tool used by investors to contribute to their financial goals. While an SIP in mutual funds may help build potential wealth in the long run, evaluating the actual returns is not as simple as looking at just the invested amount and the final value. Since investments are made periodically, each instalment has a different holding period. This is where Extended Internal Rate of Return or XIRR comes into use. XIRR may provide a practical way to calculate returns for your SIPs.
Understanding XIRR in mutual funds
In the world of mutual funds, XIRR serves to calculate eeetimes returns when there are multiple cash flows at different times. Unlike a lumpsum investment, which uses CAGR, SIPs require a tool that accounts for the different investment dates. XIRR helps in arriving at annualised returns considering both inflows and outflows.
For instance, when an investor contributes Rs. 5,000 monthly into an SIP for three years, each instalment has a different holding period. XIRR takes all these transactions into account and provides a single return rate that reflects the actual performance of the SIP.
*For illustrative purpose only
Why XIRR is useful for SIP returns
As stated above, SIP returns are not simply a result of the comparison between total investment and current value, because each investment has a different length of time. XIRR addresses this by considering the time value of money.
Some of the benefits of using XIRR in mutual funds include:
- It provides a detailed picture of returns compared to simple averages.
- It can help investors assess if their investment plan is aligned with expectations.
- It considers both partial withdrawals and redemptions along with ongoing contributions.
Step-by-step guide to calculating SIP returns using XIRR
Calculating SIP returns using XIRR may seem technical, but it can be done with the help of a spreadsheet tool.
Step 1: List all cash flows
Create a table with two columns: transaction date and the corresponding cash flow. Each SIP instalment is an outflow, so it should be recorded as a negative value. For example, if Rs. 5,000 is invested every month, record it as -5000 against the respective dates.
Step 2: Add redemption or current value
If you redeem your SIP or want to calculate the value as of today, add the redemption amount or current fund value as a positive entry on the corresponding date.
Step 3: Apply the XIRR formula
In Excel or Google Sheets, use the XIRR formula:
XIRR (values, dates)
Here, “values” refers to the column with cash flows (negative for investments, positive for redemptions/current value), and “dates” refers to the column with the corresponding dates.
Step 4: Interpret the result
The XIRR function gives the annualised rate of return for the SIP. This reflects how the mutual fund investment has performed over the chosen period.
*For illustrative purpose only
Points to keep in mind while using XIRR
- XIRR shows annualised returns, which can help compare performance across different timelines.
- Returns are not guaranteed and depend on market performance.
- A higher or lower XIRR does not indicate future outcomes, it only reflects past performance.
Using an online XIRR calculator
For investors who may not be comfortable using spreadsheets, an online XIRR calculator can be helpful. These calculators allow you to input SIP amounts, investment dates, and current or redemption values to estimate annualised returns. They can provide a convenient way to understand how mutual fund SIPs may have performed over time without manually applying formulas.
Conclusion
XIRR is a tool that evaluates the performance of SIPs in mutual funds, as it accounts for periodic investments and their varying durations. While it can give a detailed picture of *historical returns, it should not be seen as a predictor of future performance. Investors may consider using an XIRR calculator or spreadsheet method to track their investments and assess if they are on track with their goals.
*Past performance may or may not be sustained in future.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.