ATK
New Delhi [India], March 19: Investing in mutual funds is a great way to grow wealth, but understanding returns is equally important. While many investors look at absolute returns, the Extended Internal Rate of Return (XIRR) is a more accurate measure, especially for Systematic Investment Plans (SIPs).
Since SIPs involve multiple investments at different times, calculating returns through XIRR provides a true picture of growth. This ensures better financial planning and helps in making informed decisions.
So, how can investors ensure accurate XIRR calculations to maximise their returns? Let’s find out.
Five ways to ensure accurate XIRR calculation to maximise returns
To get a true reflection of mutual fund returns, investors need to follow a systematic approach when calculating XIRR. Here are five key factors that help ensure accuracy and maximise returns:
Include all cash flows
When calculating XIRR, it is essential to include every single cash flow associated with the investment. This means adding all SIP contributions, any additional lump sum investments, and withdrawals (full or partial).
Each transaction has an impact on the final return percentage and missing even one can distort the results. Investors should maintain a detailed record of their transactions and update them periodically to ensure that the calculation reflects the actual investment scenario.
Use correct dates for transactions
XIRR considers the time value of money, meaning that the timing of each investment and withdrawal significantly impacts the return. Recording incorrect dates, even by a few days, can alter the final return figure.
It is crucial to track the exact dates on which SIP instalments, additional investments, or redemptions occur. If an investor receives dividends or makes any withdrawals, those must also be recorded with their precise transaction dates to avoid inaccuracies in the final XIRR calculation.
Consider partial redemptions and dividend payouts
Many investors overlook the impact of partial withdrawals and dividend payouts when calculating returns. However, these cash flows affect the overall investment performance. If an investor redeems part of their investment, that amount should be treated as an outflow in the XIRR calculation.
Similarly, dividend payouts, whether reinvested or taken as cash, must be included in the computation. Ignoring these transactions can result in an overstated or understated return, leading to misleading investment decisions.
Leverage SIP calculators and spreadsheets
Calculating XIRR manually can be complex and prone to errors, making spreadsheet tools like Excel highly beneficial. Excel’s built-in XIRR function allows investors to input cash flows and their respective dates to get an accurate rate of return.
While most online SIP calculators do not directly calculate XIRR, they provide an easy way to estimate returns based on a fixed assumed growth rate. For a precise measure of SIP performance, investors can use spreadsheet-based XIRR calculations alongside SIP calculators to gain better financial insights and plan effectively.
Compare XIRR with benchmark indices
Just knowing the XIRR of an investment is not enough; it should be evaluated against relevant benchmarks like NIFTY 50 or Sensex. Benchmark comparison helps investors understand whether their mutual fund investments are performing well relative to the market.
If the XIRR is significantly lower than the benchmark, it might indicate that the investment is underperforming, prompting the investor to reassess their portfolio. On the other hand, a higher XIRR suggests that the investment is yielding competitive returns, validating the investment strategy.
Ending note
For investors in mutual funds, XIRR provides a clearer picture of returns, especially in mutual fund investments made through SIPs. Ensuring accurate calculation requires tracking all transactions, maintaining correct dates, including partial redemptions, and using reliable tools.
By following these steps, investors can better analyse their portfolio performance and make informed decisions to maximise returns.
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