CAGR vs. XIRR
Your Money Doesn’t Grow in a Straight Line!
When it comes to measuring investment returns, numbers can sometimes be deceptive. The road to wealth isn’t always a straight path—it’s full of twists, turns, and occasional bumps.
Have you ever checked your investment portfolio and seen different return numbers—CAGR here, XIRR there, and maybe even absolute growth? It can be confusing, but let’s break it down in a way that makes sense.
CAGR (Compound Annual Growth Rate)
CAGR shows how much an investment grows every year on average over a period of time. It helps understand steady growth by smoothing out ups and downs. It is great when you make a single, lump sum investment and want to know how it has grown annually over time.
Best for: Fixed investments, like a stock or real estate you bought once and held for years.
Example: You invested ₹1,00,000 in 2020, and it grew to ₹2,00,000 in 2025. CAGR tells you the steady annual growth rate over those 5 years.
EV = Ending Value
BV = Beginning Value
n = Number of years
CAGR is approximately 14.87% per year over the 5-year period.
Also, let’s understand that how CAGR and a normal average (arithmetic mean) are different in how they measure growth over time.
Key Differences:
CAGR considers compounding: It represents the smoothed annual rate at which an investment grows over a period, assuming compounding. It gives a true rate of return by considering how each year’s growth affects the next year.
Normal average ignores compounding: It simply adds up yearly returns and divides by the number of years, which can be misleading.
XIRR (Extended Internal Rate of Return)
XIRR is what you use when your investments involve multiple transactions over time—like SIPs, withdrawals, or reinvestments. It gives you the actual return considering when each amount was invested.
Best for: SIPs, mutual funds, real estate with multiple cash flows.
Example: If you invest ₹10,000 every month in a mutual fund for 5 years, CAGR won’t work. XIRR will tell you the true return based on when each ₹10,000 was invested.
You invest ₹10,000 every year for 3 years.
After 3 years, your total investment is ₹30,000, but the value grows to ₹40,000.
XIRR calculates the actual return considering when you invested each ₹10,000.
Calculating XIRR manually is a tedious, if not impossible, process due to its iterative nature, but it can be easily done using Excel’s XIRR function.
Now that we've crunched the numbers and tackled the jargon, let's break it down with a fun and simple analogy!
Your Kitchen Jar of Dry Fruits
Imagine you have a kitchen jar where you store dry fruits (or cookies!).
CAGR Approach: On Day 1, you weigh the jar and do nothing for 5 years. On the final day, you weigh it again. CAGR assumes a smooth, steady increase (or decrease), as if the cookies multiplied or disappeared evenly over time.
XIRR Approach: But in reality, you keep snacking, adding cookies, and may be swapping in some dry fruits at different times. XIRR keeps track of every single addition and removal, calculating the actual impact of all your munching and refilling to show the actual change in your jar’s quantity over time.
So See? Finance can actually be as fun as cookies!
How It Relates to Your Investments?
SIP = Adding nuts at different times (regular investments)
SWP = Taking out some nuts now and then (withdrawals)
XIRR = Tracking the real return, considering every addition and removal
Bottom Line:
If you’ve made a one-time investment and left it untouched, CAGR is your go-to.
If you invest regularly or withdraw occasionally, XIRR gives a more accurate picture.
Understanding these two can help you make better financial decisions and track your portfolio the right way!