What Is CAGR? Meaning, Formula, Uses & Difference vs XIRR

In investing and financial analysis, knowing about the growth of your investments is important. One metric widely used by investors and analysts is the Compound Annual Growth Rate (CAGR). It offers a clear picture of how an investment has performed over time, smoothing out year-to-year fluctuations. While CAGR provides a reliable snapshot of average growth, it is often compared to XIRR, another performance metric used in finance.

What is XIRR?

XIRR, or Extended Internal Rate of Return, is a financial metric that calculates the annualised return on the type of investments that see multiple cash flows at irregular intervals. Unlike the simple IRR, which assumes equal time intervals between cash flows, XIRR accounts for exact dates, making it ideal for real-world scenarios such as SIPs, mutual fund investments, or loans with uneven payments.

To calculate XIRR, use the following formula:

NPV=i=0∑n​(1+r)(Di​−D0​)/365Ci​​=0

Where:

Ci = Cash flow at time i (negative for investment, positive for returns)

Di​ = Date of cash flow i

D0​ = Date of first cash flow

r = XIRR or annualised return

XIRR identifies the rate r at which the net present value (NPV) of all cash flows becomes zero, taking into account the timing of each cash movement.

What is CAGR?

Compound Annual Growth Rate, also called CAGR, reflects the average annual growth rate of an investment over a defined period. This metric assumes that the investment grows at a steady rate each year, thereby smoothing year-to-year volatility.

However, in reality, investments rarely grow at the same rate every year. Returns may be high in one year and low or negative in another. CAGR does not reflect these fluctuations. Instead, it answers a simple question: At what constant annual rate would an investment have grown if it had increased evenly from its starting value to its ending value? 

If you are wondering how to calculate CAGR, you can use the following formula:

CAGR=(Beginning Value ፥ Ending Value​)1/n – 1

Where:

• Ending Value is the final value of the investment
• Beginning Value is the initial investment value
• n is the number of years

Key Differences Between XIRR and CAGR

Here are different parameters that highlight how XIRR differs from CAGR:

Calculation Method

CAGR is calculated when there is only one investment and one redemption. In contrast, XIRR is used when investments occur on different dates. If you invest ₹10,000 every month through an SIP and redeem the total after five years, XIRR calculates returns by adjusting for each investment date.

Cash Flow Inclusion

CAGR does not account for mid-period cash flows and calculates returns based solely on the initial and final values. XIRR combines all cash flows with their actual dates.

Investment Types

CAGR works well for one-time investments, such as fixed deposits or long-term equity positions, where you do not make any additional investments in the mid-term. XIRR suits investments such as SIPs, mutual funds, or portfolios involving frequent investments and periodic withdrawals.

Rate of Return

CAGR shows an average annual growth rate. It assumes smooth compounding over time. XIRR reflects the actual annualised return earned, adjusting for timing differences in cash flows, thus providing a more realistic performance measure.

Complexity

CAGR is easy to compute and interpret, requiring minimal data and basic arithmetic. XIRR is computationally complex, typically calculated using financial software or spreadsheets, due to its dependence on iterative methods and precise cash flow timing.

XIRR vs CAGR: Example Calculations

Example of XIRR Calculation

Suppose over the years, you make several investments and withdrawals. Here is the breakdown of the same:

• 01-Jan-2021: You invest ₹1,00,000
• 01-Jul-2021: You invest ₹50,000
• 01-Jan-2022: You withdraw ₹30,000
• 01-Jan-2023: Your investment value becomes ₹1,60,000 (final redemption)

To apply the above-mentioned formula to the given example, let’s take 01-Jan-2021 as the base date.

Now calculate the differences between the days:

• 01-Jan-2021 → 0 days
• 01-Jul-2021 → 181 days
• 01-Jan-2022 → 365 days
• 01-Jan-2023 → 730 days

Substitute the values:

-100000 / (1 + r)^(0 / 365)

-50000 / (1 + r)^(181 / 365)

+30000 / (1 + r)^(365 / 365)

+160000 / (1 + r)^(730 / 365)

= 0

Which simplifies to:

-100000

-50000 / (1 + r)^0.4959

+30000 / (1 + r)^1

+160000 / (1 + r)^2

= 0

Since it is difficult to solve this equation manually using basic algebra, we will turn to Excel.

In Excel, enter:

=XIRR(values, dates)

Values range:

-100000, -50000, 30000, 160000

Dates range:

01-01-2021, 01-07-2021, 01-01-2022, 01-01-2023

After iteration, Excel calculates XIRR as 14.8% per annum.

Example of CAGR Calculation

Suppose you have invested ₹100,000 in a mutual fund scheme on 1 January 2018. Exactly 5 years later, on 1 January 2023, the investment value becomes ₹201,136. To calculate the CAGR, first identify the required values for the formula.

• Beginning Value = ₹100,000
• Ending Value = ₹201,136
• Number of Years = 5

Now, substitute the values into the CAGR formula mentioned above:

• CAGR = (201,136 / 100,000)^(1 / 5) − 1
• CAGR = (2.01136)^(0.2) − 1

Next, calculate the exponent:

• CAGR = 1.15 − 1
• CAGR = 0.15

Convert this into a percentage:

• CAGR = 15%

This means your investment grew at an average annual rate of 15% every year over the 5-year period. Even though the actual yearly returns may have fluctuated, CAGR smooths those fluctuations and shows a steady annual growth rate.

Pros of XIRR

Using XIRR offers the following perks:

Time-Weighted Accuracy

XIRR factors in the time value of money. It assigns greater weight to earlier cash flows. The benefit? Returns are not overstated or understated, especially when investments and redemptions occur at different points in time.

Realistic Return Measurement

XIRR reflects actual investor experience rather than theoretical growth. Since it uses real cash flow timing, the return figure reflects what you actually earned, not an assumed or averaged annual growth rate.

Allows Portfolio-Level Evaluation

XIRR can calculate returns for an entire portfolio with multiple investments and withdrawals. You can use it to assess overall portfolio performance instead of evaluating each investment in isolation.

Partial Withdrawals

Unlike CAGR, XIRR adjusts returns for partial redemptions. Every withdrawal you make is treated as a cash inflow on its actual date. As a result, the final return remains accurate and mathematically consistent.

Effectiveness

XIRR is effective regardless of your investment duration. Whether the holding period is a few months or several years, it annualises returns accurately without requiring uniform investment intervals.

Cons of XIRR

Here are the key drawbacks of XIRR:

• For complex cash flows with alternating positive and negative values, XIRR may produce multiple mathematically valid solutions, making it ambiguous and difficult to interpret.
• XIRR only measures return, ignoring investment risk. Two investments with the same XIRR may carry vastly different risks, which the metric fails to capture.
• XIRR is purely cash flow-based. It does not account for market volatility, economic changes, or external factors that can impact actual investment outcomes.
• Inaccurate or incomplete cash flow records can distort XIRR calculations. Missing a single inflow or outflow may result in an incorrect internal rate of return.

Pros of CAGR

Here are some of the benefits of using CAGR:

Simplifies Growth Tracking

CAGR condenses varying annual returns into a single growth rate. It allows you to understand overall performance without analysing each year individually, making comparisons across investments or periods simple.

Investment Comparison

CAGR provides a uniform growth rate. It enables direct comparison between different assets, portfolios, or funds, regardless of fluctuations in yearly returns.

Long-Term Planning

CAGR helps forecast investment growth over multiple years, enabling investors to plan systematically for financial goals such as retirement, education, or wealth accumulation with realistic growth expectations.

Business Analysis

Businesses use CAGR to track growth in revenue, profit, or market share over time. It helps decision-makers see trends, evaluate strategies, and make smarter choices for operations or investments.

Risk Assessment

CAGR shows the average growth of an investment, helping you spot slow-growing or weak-performing assets and make better decisions about where to put your money.

Cons of CAGR

Here are the key drawbacks of CAGR:

• CAGR metric and CAGR calculators are designed for long-term performance evaluation. Using it for short periods can exaggerate growth trends and provide misleading projections for rapidly changing investments.
• Minor differences in initial or final values drastically affect CAGR. This can overstate or understate returns if abnormal market conditions skew either endpoint.
• CAGR does not account for additional investments, withdrawals, or dividends reinvested. This limits its accuracy in assessing portfolio returns with irregular cash flows.
• CAGR does not reflect economic events, policy changes, or sector-specific shocks. It fails to indicate whether growth was due to favourable conditions or sustainable business performance.

Conclusion

CAGR and XIRR show how investments grow over time, but they don’t capture factors like market mood, economic changes, or industry problems. Smart investors should use these numbers along with risk checks, spreading investments, and planning for different scenarios. Combining growth metrics with market understanding helps make stronger decisions and predict how outside factors could affect a portfolio.