How to Calculate SIP Returns: The Correct Method for CAGR or XIRR in Excel

When investing through Systematic Investment Plans (SIPs), one of the most important questions is how to calculate your returns. In this article, we will explore the differences between CAGR (Compounded Annual Growth Rate) and XIRR (Extended Internal Rate of Return) and determine which method is best for SIP calculations in Excel. We will also explain how to apply each formula correctly based on your investment pattern.

Understanding CAGR and XIRR

Before diving into the calculations, it is crucial to understand the differences between CAGR and XIRR:

CAGR

CAGR is a measure of the average rate at which an investment increases over a specific period, assuming that the investment is reinvested at an annual rate. CAGR provides a smooth, averaged return over a period, which is helpful for comparison purposes but does not account for the variability in cash flows.

XIRR

XIRR, on the other hand, stands for the Extended Internal Rate of Return. This formula is more accurate for investments with irregular cash flows, providing a more precise picture of the overall return. XIRR considers the timing and amounts of each cash flow individually, making it a better fit for SIPs where the investment amounts and intervals can vary.

When to Use CAGR Formula in Excel

The CAGR formula can be used if the interval between payments is uniform and the payment amounts are the same. This is common in an SIP where the investment amount and intervals are fixed. Here is how you can use the formula in Excel:

Enter the initial investment amount in cell A1. Enter the final investment value in cell A2. Enter the number of periods in cell A3 (for example, the number of months). Enter the formula POWER((A2/A1),1/A3)-1 in cell A4 to calculate CAGR.

For example, if you invest 20,000 INR per month for 12 months and your final value is 240,000 INR, the CAGR formula would be:

POWER((240000/220000),1/12)-1

When to Use IRR Formula in Excel

The IRR formula is appropriate when the interval between payments is uniform but the payment amounts vary. This situation could arise if your SIP investment amount varies each month but the intervals remain the same. Here’s how to use IRR:

Enter the beginning investment amount in cell A1. Enter the amounts of each investment in cells A2 through A13 (assuming monthly investments). Enter the formula IRR(A1:A13) in cell A14 to calculate IRR.

Using the same example as before, if your investments were 20,000 INR, 5,000 INR, and 12,000 INR for the first three months, the IRR would be calculated as:

IRR({220000,20000,5000,12000,...})

When to Use XIRR Formula in Excel

The XIRR formula is the most comprehensive method for SIP returns, especially when the interval between payments is not uniform. This is applicable if the investments are made at irregular intervals and with different amounts. Here’s how to use XIRR:

Enter the date of each investment in cells B1 through B13. Enter the amounts of each investment in cells A2 through A13. Enter the formula XIRR(A2:A13,B2:B13) in cell A14 to calculate XIRR.

For example, if you invested 20,000 INR on January 1, 2021, 5,000 INR on January 4, 2021, and 12,000 INR on February 12, 2021, the XIRR would be calculated as:

XIRR({20000,5000,12000},{"1/1/2021","1/4/2021","2/12/2021"})

Conclusion

Based on the investment pattern, choose the appropriate method to calculate your SIP returns. For a fixed, uniform schedule with the same investment amount, CAGR is suitable. If the investment amount varies but the intervals are fixed, use IRR. For irregular investments with varying intervals, XIRR is the best choice. Using these formulas in Excel can provide you with a more accurate understanding of your SIP performance.