Introduction

XIRR, CAGR, and Absolute Returns are all measures of the return on an investment, but they differ in terms of the information they provide and the method they use to calculate the return.

As an investor, borrower, lender, the above metrices are useful and it is critical to understand these metrices in the calculation of the return on investments or cost of the funds. These metrices will provide accurate picture on the rate of return or cost.

Understand XIRR, CAGR, and Absolute returns with example

1. XIRR (Internal Rate of Return): XIRR is a measure of the average annual rate of return on an investment that takes into account the timing and size of cash flows (i.e., deposits and withdrawals) into or out of the investment. XIRR is useful for investments where the cash flows are irregular or not constant, such as mutual funds, where the investor may make several deposits and withdrawals over time.

For example, consider an investor who invested Rs. 100,000 in a mutual fund on January 1, 2018, and made additional investments of Rs. 50,000 on July 1, 2018, and Rs. 30,000 on January 1, 2019. The investor also made withdrawals of Rs. 20,000 on October 1, 2018, and Rs. 40,000 on March 1, 2019. The XIRR for this investment would take into account the timing and size of each of these cash flows to calculate the average annual rate of return on the investment.

2. CAGR (Compound Annual Growth Rate): CAGR is a measure of the average annual growth rate of an investment over a specified time period. It represents the growth rate that would have taken the investment from its starting value to its ending value if the growth rate were compounded annually over the entire time period.

For example, consider an investor who invested Rs. 100,000 in a stock on January 1, 2018, and sold the stock for Rs. 150,000 on January 1, 2022. The CAGR for this investment would be calculated by taking the compounded annual growth rate over the four-year period from January 1, 2018, to January 1, 2022.

3. Absolute Returns: Absolute returns represent the total return on an investment over a specified time period, regardless of the starting or ending value of the investment. Absolute returns are calculated as the difference between the ending value of the investment and the starting value, expressed as a percentage of the starting value.

For example, consider an investor who invested Rs. 100,000 in a bond on January 1, 2018, and received interest payments of Rs. 10,000 per year. The absolute return for this investment would be calculated as the difference between the ending value of the investment (Rs. 140,000) and the starting value (Rs. 100,000), expressed as a percentage of the starting value.

Conclusion

In summary, XIRR takes into account the timing and size of cash flows into or out of an investment, while CAGR measures the average annual growth rate of an investment over a specified time period. Absolute returns represent the total return on an investment over a specified time period, regardless of the starting or ending value. All three measures can be useful in evaluating the performance of an investment, but it is important to understand the information they provide and the method used to calculate the return.