Investors generally focus on two key metrics while evaluating the performance of a particular investment – CAGR and XIRR. While CAGR, the compound annual growth rate, is a metric that helps you know the average growth rate of an investment over time, XIRR helps you calculate the ROI of investments that have irregular cash flows. Read on to know the difference between XIRR and CAGR.
What is XIRR?
The Extended Internal Rate of Return is a financial metric that helps you calculate the return on investments that have irregular cash flows. XIRR is most helpful in the case of investments where money is deposited or withdrawn multiple times at different times, for instance, SIPs (systematic investment plans). XIRR accounts for the time value of money – the idea that money that is available now is worth more than the same amount in the future due to its potential earning capacity.
What is CAGR?
An investment’s compound annual growth rate is a metric that measures its average annual growth rate over time, assuming that the growth compounds every year. This assumption is not consistent with how most investments work since most investments are subject to market volatility. CAGR is only calculated using the initial value, final value and the period of an investment. The CAGR metric is particularly helpful for long-term investments where you wish to smooth-out short-term volatility to get a clearer picture of the overall growth trend. You can use the CAGR metric to assess the performance of different stocks, mutual funds, or markets over the same period.
Use of a compound annual growth rate calculator –
A CAGR calculator is a free online tool that helps you accurately calculate the CAGR of your investments, thereby helping you make informed investment decisions by comparing the historical returns of various investments.
Key differences between XIRR and CAGR –
The following table enlists the main differences between the Extended Internal Rate of Return and the compound annual growth rate of an investment –
| Aspect | XIRR | CAGR |
| Cash flow | XIRR can handle multiple cash flows, even irregular ones. | CAGR assumes a single initial investment and a single final value. |
| Timing sensitivity | XIRR considers the exact dates of cash flows. | CAGR ignores timing within the investment period. |
| Calculation complexity | Calculating XIRR is complicated and often requires software. | CAGR’s calculation is easy. You can also calculate CAGR manually. |
| Best used for | XIRR is used for investments with multiple transactions. | CAGR accounts for single investments held for a specific period. |
| Accuracy for variable investments | Accuracy-wise, XIRR calculations are more accurate. | CAGR calculations are not as accurate when compared to XIRR calculations. |
| Time period flexibility | XIRR can handle varying time periods. | CAGR assumes a fixed time period. |
| Real-World Application | Real-world applications include SIPs, real-estate investments, and private equity | CAGR has applications in the domain of stocks, mutual funds, and market indices. |
In conclusion,
CAGR and XIRR, both have their limitations too. In the case of XIRR, their calculations are too complex. Furthermore, small errors in dates or amounts can significantly affect the result. XIRR also assumes that cash flows are reinvested in the fund. In the case of CAGR, a key disadvantage is that it assumes steady growth and does not account for market volatility.
