What is XIRR? Why does it differ from an absolute return?

Vinod Choudhary
Feb 5
3 min read

In the world of finance and investments, understanding various metrics is crucial for making informed decisions. Two important metrics are XIRR (Extended Internal Rate of Return) and absolute return. While both are used to evaluate the performance of investments, they differ in their approach and the insights they provide. In this blog, we'll explore what XIRR is, why it differs from absolute return, and why it's important for investors. Let's dive in!

What is XIRR?

Definition:
- XIRR stands for Extended Internal Rate of Return. It is a financial metric used to calculate the internal rate of return for a series of cash flows that occur at irregular intervals. Unlike the traditional IRR, which assumes periodic cash flows, XIRR can handle cash flows that occur at any point in time.
Calculation:
- XIRR is calculated using an iterative process to find the discount rate that sets the net present value (NPV) of all cash flows (both inflows and outflows) to zero.
- The formula for XIRR is complex and typically solved using financial software or calculators.
Importance:
- Accurate Performance Measurement: XIRR provides a more accurate measure of an investment's performance, especially when cash flows are irregular.
- Comparability: It allows investors to compare the performance of investments with different cash flow timings on a level playing field.

Why Does XIRR Differ from Absolute Return?

Absolute Return:

Definition: Absolute return is the total return of an investment over a specific period, expressed as a percentage of the initial investment.
Calculation: It is calculated as the difference between the final value and the initial value of an investment, divided by the initial value, and then multiplied by 100 to get a percentage.

Differences:

Time Value of Money:
- XIRR: Takes into account the time value of money by considering when cash flows occur. It discounts future cash flows to their present value.
- Absolute Return: Does not consider the time value of money. It simply measures the total growth of an investment over a period.
Cash Flow Timing:
- XIRR: Can handle irregular cash flows, making it suitable for investments with varying cash flow timings.
- Absolute Return: Does not account for the timing of cash flows. It only considers the initial and final values of the investment.
Annualized Measure:
- XIRR: Provides an annualized rate of return, making it easier to compare investments with different holding periods.
- Absolute Return: Provides a total return over the investment period but does not annualize the return.

Example:

Imagine you invested in a project with the following cash flows:

Initial investment: ₹ (-1,00,000)
Cash inflow after 1 year: ₹30,000
Cash inflow after 2 years: ₹50,000
Cash inflow after 3 years: ₹70,000
Cash inflow after 4 years: ₹80,000

Using XIRR, you can calculate the annualized return that considers the timing of these cash flows. This provides a more accurate measure of the investment's performance compared to simply calculating the absolute return, which would not account for the time value of money or the irregular cash flow timings.

How do you assess your portfolio's performance?

XIRR
Absolute Returns

Conclusion

XIRR is a powerful metric that provides a more accurate measure of an investment's performance by considering the time value of money and irregular cash flows. Unlike absolute return, which only measures total growth, XIRR annualizes the return and accounts for the timing of cash flows. By using XIRR, investors can gain deeper insights into their investments and make more informed decisions. Start evaluating your investments with XIRR today and take the first step towards a more comprehensive understanding of your financial performance.

Disclaimer: This blog is for educational purposes only. The securities/investments mentioned here are not recommendations.

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