Reading returns: absolute, CAGR, XIRR, and why SIP returns look different
Absolute return hides time. CAGR is for lump sums. XIRR is for SIPs, and it can look very different from both.
Two people can look at the same fund and quote completely different returns, and both can be right. One is quoting absolute return, another CAGR, and your own SIP statement shows something called XIRR. If you do not know which is which, every comparison you make will be wrong. This chapter sorts them out with one set of numbers.
Absolute return: the simplest, and the least useful
Absolute return is just how much your money grew, as a percentage, with no mention of time.
₹1 lakh that becomes ₹1.5 lakh has an absolute return of 50 percent. Fine, but was that over one year or over ten? Fifty percent in one year is extraordinary. Fifty percent over ten years is below a bank deposit. Absolute return hides the time, so it is only meaningful for periods under a year.
CAGR: one-time investments, with time included
CAGR, compound annual growth rate, answers a better question: at what steady yearly rate would the money have had to grow to get from start to finish? It smooths out the ups and downs into one annual figure.
| Invested once | ₹1,00,000 |
| Value after 3 years | ₹1,50,000 |
| Absolute return | 50% |
| CAGR | About 14.5% a year |
Notice it is not 50 divided by 3. Compounding means each year's growth builds on the last, so the steady rate that gets you there is 14.5 percent, not 16.7. Fund factsheets quote CAGR for 1, 3, 5 and 10 year periods, and that is the right way to compare two funds over the same period.
XIRR: the number for SIPs
CAGR assumes one lump sum at the start. A SIP is dozens of small investments on different dates, each one invested for a different length of time. The money you put in last month has barely had time to move. The money from three years ago has done most of the work. XIRR handles this: it finds the single yearly rate that makes all those dated cash flows add up to your current value. Spreadsheets have an XIRR function, and most portfolio screens use the same method.
Why SIP returns look different from the fund's return
This is the part that confuses almost everyone, so take it slowly.
| SIP | ₹5,000 a month for 12 months |
| Total invested | ₹60,000 |
| Value at the end of month 12 | ₹66,000 |
| Absolute return | 10% |
| XIRR | About 18.9% a year |
How can 10 percent become 18.9 percent? Because the ₹60,000 was not invested for a year. The first ₹5,000 was in for twelve months, the last ₹5,000 for one month. On average, each rupee was invested for only about six and a half months. Earning 10 percent in six and a half months is roughly 19 percent a year. XIRR is telling the truth about the rate. Absolute return is telling the truth about the rupees. You need both: XIRR to judge the investment, rupees to judge progress towards your goal.
The same effect runs in reverse. If markets rise for most of the year and then fall in the last two months, your SIP XIRR can look worse than the fund's one-year CAGR, because most of your money arrived at the higher prices. Neither number is lying. They measure different things.
A short checklist for reading any return:
- Ask what period it covers. A return without a period is a slogan, not a number.
- Ask whether it is a lump sum figure (CAGR) or a dated cash flow figure (XIRR).
- Compare like with like: a fund's 3-year CAGR against another fund's 3-year CAGR, your SIP's XIRR against your other SIPs' XIRR.
- Remember that every past return is history. It says what happened, not what will happen.
Remember
- Absolute return ignores time. Use it only for periods under a year.
- CAGR is the steady annual rate for a lump sum. ₹1 lakh to ₹1.5 lakh in 3 years is about 14.5%, not 16.7%.
- XIRR handles many dated instalments. It is the right number for a SIP.
- A SIP with 10% absolute return in a year can show 18.9% XIRR, because the average rupee was invested for only six months.
- Compare like with like, over the same period. Past returns describe history, not the future.