📊

Absolute Return vs CAGR vs XIRR

In this article we would cover:

  1. What is Absolute return, CAGR, XIRR
  1. Their limitations
  1. Why does it make sense to use XIRR

We will use this sample portfolio as an example -

Sundar invested Rs. 100 every first day of the month for three months. He then exited the portfolio at Rs. 310 exactly after three months.

Sundar's Trade book

Cashflow AmountCashflow Date
-100
-100
-100
310


A negative value represents outflow/investment/loss (money going out from your pocket). And Positive value represents the inflows/profit (money coming in your pocket).

Absolute Return

Absolute return is the most basic way to calculate returns from an investment. It does not take the time factor into consideration. It simply considers only the amount gained/lost from an investment.

Absolute return =  (Vfinal − VinitialVinitial) \begin{equation*}Absolute\ return\ =\ \ \left(\frac{V_{final} \ -\ V_{initial}}{V_{initial}}\right)\end{equation*}

Sundar's absolute return would be (310−300)/300=3.33(310 - 300)/300 = 3.33%

⚠️
Notice that there's no time factor in the formula. This is a limitation that CAGR tries to solve.

CAGR (Compounded Annual Growth Rate)

CAGR is a common metric used in the financial industry to calculate the annualized return of an investment.

CAGR =  (VfinalVinitial)1/t − 1 \begin{equation*}CAGR\ =\ \ \left(\frac{V_{final}}{V_{initial}}\right)^{1/t} \ -\ 1\end{equation*}

While CAGR considered the overall duration of investment, it still does not work for more than two transactions —

Sundar′s CAGR =  (310300)1/0.25 − 1 = 14.01%\begin{equation*} Sundar's\ CAGR\ =\ \ \left(\frac{310}{300}\right)^{1/0.25} \ -\ 1 \ = \ 14.01\% \end{equation*}

In the above calculation, 0.25 = one quarter

This calculation assumes that Sundar invested Rs. 300 on Jan 1st and received Rs. 310 on Apr 1st, 2021. Which is not correct.

💡
If Sundar's portfolio keeps growing at the same absolute rate of 3.33% per quarter, his portfolio would generate a 14.01% annualized return.
😓
CAGR is used to calculate point-to-point returns generated for a particular investment (one buy & one sell transaction) and is not useful for more than two transactions.

📊 CAGR Calculator
Calculate the Compound Annual Growth Rate for your investments with a single purchase and sale transaction.
Try CAGR Calculator →

XIRR (eXtended Internal Rate of Return)

Internal Rate of Return (IRR) is used to calculate annualized returns when the transactions happen periodically (say, Mutual Fund SIP set for 1st day of every month).

XIRR is an extended version that works for non-periodic transactions.

Both, IRR & XIRR, considers timing of individual transaction for calculating annualised returns.

Considering the complexity of the XIRR calculation, I will leave it up to you for further reading (check references).

There is a great utility function provided by MS Excel & Google Sheet - XIRR()

Screenshot from Google Sheets demonstrating the use of XIRR function
XIRR(cashflow_amounts, cashflow_dates)

Sundar′s XIRR=22.01%Sundar's\ XIRR = 22.01\%

🚀 XIRR Calculator
Calculate accurate annualized returns for multiple transactions. Upload your Zerodha tradebook or manually enter cash flows to get your XIRR.
Try XIRR Calculator →

✅
By now, you would come to a realization that to compare two different portfolios, XIRR is the most reliable way. And it is meaningless to compare absolute returns or CAGR for that matter.

Ready to Calculate Your Returns?

🚀 XIRR Calculator
Best for portfolios with multiple transactions. Upload your Zerodha tradebook or manually enter cash flows.
Calculate XIRR →
📊 CAGR Calculator
Perfect for single buy-sell transactions. Get your annualized growth rate instantly.
Calculate CAGR →