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I searched about IRR / XIRR (when the installment period is irregular).

I have two questions:

1) Why is IRR(or XIRR) considered to be a better return metrics than CAGR when it comes to making SIP ? 2) In case of making a SIP , how can I know / predict the future cash flow ? So, isn't it (IRR) bit misleading ?

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IRR and XIRR (if applied properly) work better when dealing with an SIP because they account for the periodic inflow of funds while CAGR does not. CAGR just takes the change between the beginning balance and the ending balance and annualizes it.

For example, suppose you start with 1,000 at the beginning of the year. At the end of the year, there is no net growth but you add 500 to your account. If you use the CAGR method, it seems like you made a 50% return (1,500/1000 - 1 = 50%), but IRR will account for the inflow and calculate the actual 0% return.

If you're trying to predict future growth, then you need to separate the contributions from the returns of the actual investments, which IRR does for you.

  • @D Stanley: Hi , thanks for the explanation. I have the doubt if I invest 1000 per month, should I consider 1000 per month as in flow? – DukeLover Aug 7 at 13:37
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    @DukeLover Yes - if you are trying to measure the performance of the underlying investments, you need to separate cash inflows from the growth of the investment. – D Stanley Aug 7 at 13:59

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