Understanding Investment Returns: Absolute Returns, CAGR & XIRR

When it comes to evaluating investment performance, three common metrics are often discussed: XIRR, CAGR, and Absolute Returns. Each of these measures offers a different perspective on how an investment has performed over time.

ABSOLUTE RETURNS

Absolute Returns measure the total return of an investment over a specific period. It is the simplest form of calculating returns and does not take into account the time factor. The formula for Absolute Returns is:

Absolute Return = ((Final Value – Initial Value)/Initial Value)*100

Example_A: If you invested Rs. 1,00,000 and it grew to Rs. 1,20,000 in 3 years, the Absolute Return would be 20% as under:

= ((120000 – 100000)/100000)*100 

= (20000/100000)*100 

= 20%

CAGR (COMPOUNDED ANNUAL GROWTH RATE)

CAGR is the mean annual growth rate of an investment over a specified time period longer than one year. It represents one of the most accurate ways to calculate and determine returns for anything that can rise or fall in value over time. The formula for CAGR is:

CAGR = ((Final Value / Initial Value)^(1/n))-1

Where n = number of years

In our Example_A our CAGR will be calculated @6.27% as under:

= ((120000/100000)^(1/3))-1 

= 6.27%

So this means that our investment of Rs. 1,00,000/- grew @ 6.27% per annum over 3 year period into Rs. 1,20,000/-

XIRR (EXTENDED INTERNAL RATE OF RETURN)

XIRR is used for calculating the internal rate of return for a series of multiple cash flows that may or may not be periodic. It’s particularly useful for investments like mutual funds/SIP where you make repeated investments at regular or irregular intervals. Let us see with an example how we can use the XIRR function in Excel to calculate the return on such irregular investments.

Example_B: Suppose you made the following investments in a mutual fund at different time intervals: 

• Rs. 50,000/- on dated 01-01-2018
• Rs. 30,000/- on dated 01-07-2019
• Rs. 20,000/- on dated 01-03-2020

And on Dec 31, 2020, the value of your investment is Rs. 1,20,000. Using the XIRR function in Excel, you would calculate the XIRR rate of return as 8.84%. Please see below image to understand how we can use XIRR function in Microsoft Excel to calculate XIRR% returns:

In conclusion, while Absolute Returns give a straightforward percentage increase, CAGR provides a smoothed annual growth rate, assuming the investment grows at a steady rate. XIRR, on the other hand, is more flexible and accommodates investments with multiple cash flows at different times. Understanding these differences is crucial for accurately assessing the performance of your investments.

I hope this article will now help you better understand your portfolio returns.