Chapter 6 of 15
Understanding Returns - XIRR, CAGR, Absolute
Three ways returns are measured and when to use each.
Ganesh got a WhatsApp forward at 7 AM.
"🔥🔥 XYZ Multicap Fund: 45% returns!! 🚀🚀 Limited time! Join our Telegram!"
He stared at it. Forty-five percent. His YouTube channel makes maybe ₹6,000 in a great month. This fund apparently makes 45% in... some time period they didn't mention.
But here's the thing: Ganesh had just started learning about mutual funds. And he'd read enough to know the question wasn't "is 45% good?" The question was "45% over what time period?"
Because that changes everything.
A mutual fund's return is the percentage gain (or loss) on your investment over a given period. How you calculate and express that return (absolute, CAGR, or XIRR) determines whether the number is meaningful or misleading.
The Three Return Numbers You'll Encounter
1. Absolute Return
The simplest calculation: (Current Value - Invested Amount) ÷ Invested Amount × 100.
Invested ₹10,000. Now it's ₹14,500. Absolute return = (14,500 - 10,000) ÷ 10,000 × 100 = 45%.
Sounds great. But when was the ₹10,000 invested? Last month? 5 years ago?
45% in 5 years is mediocre. A savings account would give you more. 45% in 6 months is spectacular. That's a bull market in action. 45% in 1 month would be nearly impossible for a legitimate fund.
Absolute return tells you nothing without the time period. This is exactly what the WhatsApp forward exploited. They showed the absolute return without telling Ganesh when the investment was made.
2. CAGR (Compound Annual Growth Rate)
CAGR answers: "If my investment grew at a consistent rate every year, what would that annual rate be?"
CAGR = (Final Value / Initial Value)^(1/years) - 1
Case A: ₹10,000 → ₹14,500 in 1 year CAGR = (14,500/10,000)^(1/1) - 1 = 45%. This is exceptional. Very rare.
Case B: ₹10,000 → ₹14,500 in 3 years CAGR = (14,500/10,000)^(1/3) - 1 = 13.2%. This is good, roughly matching the Nifty 50 historical average.
Case C: ₹10,000 → ₹14,500 in 5 years CAGR = (14,500/10,000)^(1/5) - 1 = 7.7%. This is below average. A savings account would nearly match this.
The WhatsApp forward said "45% returns!" That's Case A math on what's probably Case B or C reality. Ganesh was right to be skeptical.
CAGR is the standard for comparing funds. When Groww or Morningstar shows "5-year returns: 14.2%", that's CAGR. It lets you compare a fund that grew from ₹100 to ₹250 over 7 years vs a fund that grew from ₹50 to ₹200 over 5 years on an apples-to-apples basis.
CAGR limitation: It assumes a single lump sum investment and a single withdrawal. It doesn't account for multiple cash flows (like monthly SIPs).
3. XIRR (Extended Internal Rate of Return)
XIRR is the return metric for SIP investors. It's the only accurate one when you have multiple investments at different dates.
When Ganesh invests ₹500 every month for 3 years, he's made 36 different investments on 36 different dates at 36 different NAVs. CAGR can't capture this. XIRR can.
XIRR calculates the annualized return that makes the present value of all your investments equal to the present value of your withdrawal, accounting for exactly when each cash flow happened.
Every major mutual fund platform (Groww, Kuvera, Zerodha, Paytm Money) shows you XIRR in your portfolio. Excel and Google Sheets also have an XIRR function. Just know that XIRR is the right number to look at for your SIP portfolio, not absolute returns, not CAGR.
Ganesh invests ₹500/month for 24 months (total ₹12,000). At the end, his portfolio is worth ₹14,400.
Absolute return: (14,400 - 12,000) ÷ 12,000 × 100 = 20%. Sounds okay.
CAGR (naively applied): (14,400/12,000)^(1/2) - 1 = 9.5%. But this is wrong. He didn't invest ₹12,000 two years ago. He invested it monthly.
XIRR (correct calculation): ~15.8% per year. Because the later SIP installments were invested for less time than the earlier ones. XIRR accounts for this precisely.
The CAGR method understated the return because it treated all the money as if it was invested 2 years ago, when most of it was actually invested less than 2 years ago.
When to Use Which Metric
| Scenario | Right metric | Why |
|---|---|---|
| Lump sum invested, withdrawn once | CAGR | Single investment, single redemption |
| Monthly SIP over multiple years | XIRR | Multiple cash flows on different dates |
| Comparing two funds over same period | CAGR | Standardized comparison |
| Quick gut-check on a forward/claim | Absolute + time period check | Expose misleading framing |
| Your actual portfolio performance | XIRR | Accounts for all your actual cash flows |
Benchmarking: What's Actually a Good Return?
The return number alone is meaningless without a benchmark.
The right question isn't "did the fund give 14%?" The right question is "did the fund give 14% when the benchmark (Nifty 50) gave 12%?" That's meaningful outperformance.
Benchmarks for common fund types:
- Large cap funds → Nifty 50 or Nifty 100
- Mid cap funds → Nifty Midcap 150
- Small cap funds → Nifty Smallcap 250
- ELSS funds → Nifty 500 or Nifty 50
- Debt funds → Their respective debt indices
A fund that gave 12% while the Nifty 50 gave 14% is actually a bad fund, even though 12% sounds good in isolation.
Ganesh made the mistake of comparing his mid-cap fund to the Nifty 50. His fund gave 15% while Nifty 50 gave 14%. "It beat the index!" he thought. But the Nifty Midcap 150 gave 18% that year. His fund actually underperformed its correct benchmark by 3%.
Rolling Returns: The Honest Way to Evaluate Funds
Point-to-point CAGR can be manipulated. Pick the start and end date strategically and any fund looks brilliant.
Rolling returns calculate performance for every possible holding period of a given length within the fund's history. If you check a fund's 3-year rolling returns, you get the 3-year CAGR for every start date (Jan 2015–Jan 2018, Feb 2015–Feb 2018, Mar 2015–Mar 2018... all the way to today).
A fund with consistent rolling returns, where it beats the benchmark in 80%+ of rolling periods, is a genuinely reliable fund. A fund that looks great only from one specific date is getting lucky.
Back to the WhatsApp Forward
Ganesh did the investigation:
He found the "45% returns" fund on Value Research. It had given 45% from a specific valley (October 2022) to a specific peak (October 2023). A perfectly cherry-picked 1-year window.
The 3-year CAGR? 11.2%. The 5-year CAGR? 9.8%. The Nifty 50 over the same periods: 12.5% and 11.1%.
The fund had underperformed the index over 3 and 5 years. The "45% returns" claim was technically true for a 1-year cherry-picked window. And completely misleading for an actual investor.
Ganesh did not join the Telegram group.
Key Takeaways
- Absolute return is meaningless without knowing the time period; always ask "return over how many years?"
- CAGR is the standard for lump-sum comparisons; it expresses return as a consistent annual rate
- XIRR is the correct metric for SIP portfolios; it accounts for different investment dates
- Always compare returns to the correct benchmark for that fund category, not just "the market"
- Rolling returns are more honest than point-to-point CAGR; look for consistency across periods
- A fund beating the index by 1–2% CAGR consistently over 10 years is actually exceptional
Calculate how your SIP is actually performing:
Go deeper into fund analysis:
- How to read a mutual fund factsheet (Sharpe ratio, alpha, beta)
- Index vs active funds: what the 10-year data shows
Ganesh invested ₹10,000 three years ago. It's now worth ₹14,049. What is the approximate CAGR?
Disclaimer: This article is for educational purposes only and does not constitute personalized financial advice. Investments are subject to market risks. Past performance does not guarantee future returns. Please consult a SEBI-registered investment adviser before making investment decisions.