Difference Between XIRR vs CAGR Explained with an Example

Investment returns are the key to smart financial decision-making. The two most commonly used metrics are XIRR and CAGR. While both may measure investment performance, they provide investors with different information because they are applied in various situations.

This article discusses key differences between XIRR and CAGR to help you decide which will be better for evaluating your investments.

XIRR stands for Extended Internal Rate of Return, an extended financial metric used to calculate investment returns by considering irregular cash flows over time. It gives an exact and accurate measure of an annualised return on investment.

This is particularly useful for stock market portfolio investors. It can analyze individual stocks precisely, determining which investments drive gains or contribute to losses.

Such insight is vital for assessing the performance of a portfolio and making good decisions. As XIRR mirrors real-life cash flow patterns, it gives clarity and actionable insight to optimize investment returns.

CAGR represents a compound annual growth rate that describes the average yearly rate of return on investments over any fixed time. It considers the initial investment, the final value, and the time to better represent growth compared to the absolute return, as it only measures point-to-point returns.

CAGR is most useful for long-term investments because it eliminates short-term fluctuations in the market and reveals trends. Therefore, it is used extensively to evaluate and compare the performance of stocks, mutual funds, or entire markets.

1. Example of CAGR Calculation

2. Example of XIRR Calculation

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1. When to Use XIRR?

• Irregular Cash Flows: XIRR is ideal for investments with periodic withdrawals or contributions, like SIPs.
• Timing Sensitivity: It considers the exact dates of cash flows, providing a precise calculation of returns.
• Real-World Scenarios: Best suited for cases where cash inflows and outflows are sporadically spread across time.

2. When to Use CAGR?

• Single Lump-Sum Investments: CAGR is most appropriate for one investment with no further contributions, such as fixed deposits.
• Constant Growth: It is based on a uniform growth rate and provides an average annualised rate of return over a given period.
• Simple Comparisons: Compare the returns of various investments with given time frames easily using CAGR.

CAGR and XIRR are excellent metrics for quantifying investment performance, but they serve different purposes. While CAGR is helpful for a one-time straight-line investment over any given period, XIRR is meant for more complex cash flows, such as SIPs or casual transactions, to accrue the return accurately.

The correct method helps you gauge your investments and make informed financial decisions.