Many people believe that there is no difference between IRR and XIRR. However, this is not true. We are going to make this confusion easy for you here.
Understanding returns in investment is very important. Returns are calculated in different ways. For example, Annualized Return (AR), Holding Period Return (HPR), Compound Annual Growth Rate (CAGR), Internal Rate of Return (IRR), Extended Internal Rate of Return (XIRR) come in this. Whenever we invest in mutual funds, the importance of XIRR increases. Some people believe that there is no difference between IRR and XIRR. However, this is not true. There is a vast difference between these two. We are going to make this confusion easy for you here.
Internal Rate of Return (IRR)
Whenever you invest more than once in a year, then the annual return of that entire investment is called IRR. Remember that it is calculated annually only.
Now let us understand this with an example. Suppose you invest Rs 12,000 in a fund for a year and you get Rs 13,000 after 1 year. That is, your return is 8.33%.
But, if you are investing Rs 1,000-1,000 on the 1st of every month from the beginning of the year to the end of the year and you get the same return i.e. Rs 13,000 at the end of the year, then your return is 15.70%.
It means if you invest 12,000 together then you get less return and if you invest little by little every month then you get more returns. This is called IRR.
Extended Internal Rate of Return (XIRR)
We also understand this from the above example. If you invest on a different date instead of investing Rs 1,000 in a SIP on the 1st of every month. That is, invest on the 1st of a month, on the 15th of the second month or on the 20th of the third month.
In this way you have invested Rs 12,000 in a year and in the end you have got the same return as above i.e. Rs 13,000. So as per the calculation of excel sheet, you have got 16.15% return. Here is your XIRR.
Now let’s understand it in another way. Suppose you have invested some amount every year instead of every month. Withdrawals have also been made in any year. Like invested 20,000 in 2010. 10,000 planted in 2011. Did not make any investment in 2012.
Till 2015, 20 thousand were invested every year. Then in 2016 did 30,000 withdrawals. Finally after 10 years in 2020 you got 2 lakhs. Now how will it be calculated? So in the excel sheet you select the date and investment of every year and multiply it by 100 then you will get XIRR.
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