6 min read
Quick Summary
- CAGR, XIRR and TWRR are all annualised returns, but each answers a different question.
- TWRR shows how the investment strategy performed, independent of when money was added or withdrawn.
- XIRR shows what your own money actually earned, considering the amount and timing of every cash flow.
- CAGR smooths a lump-sum investment's start and end values into one constant annual rate.
- Before comparing return numbers, ask what exactly each one is measuring.
Table of Contents
When investors review their portfolio performance, the first thing they usually look for is returns. But then comes the confusion. Your portfolio statement may show XIRR, a PMS report may show TWRR, while mutual fund factsheets and advertisements often highlight CAGR. All three are expressed as annualised returns.
So, are they measuring the same thing? Not really.
The discussion is not about which metric is “better”. It is about understanding what each metric measures and when it should be used. Let me walk you through these terms with one ₹1 crore example.
Example
Imagine an investor starts with ₹1 crore in a portfolio. The investor then makes additional investments at different points in time.
| Date | Transaction | Amount invested / portfolio value |
|---|---|---|
| 1 April 2021 | Initial investment | ₹1.00 Cr |
| 1 April 2022 | Additional investment | ₹50 Lakh |
| 1 April 2023 | Additional investment | ₹50 Lakh |
| 31 March 2026 | Final value | ₹3.60 Cr |
The investor has therefore invested a total of ₹2 crore, and the portfolio is now worth ₹3.60 crore.
Now imagine that the investment report shows three different numbers:
CAGR: 29.17% | XIRR: 14.66% | TWRR: 19.1% (illustrative)
Which one is correct? All three can be correct. They are simply answering different questions.
1. TWRR – How Did the Investment Perform?
TWRR, or Time-Weighted Rate of Return, measures the performance of the portfolio or investment strategy while removing the impact of external cash flows such as additional investments and withdrawals. This makes TWRR particularly useful when we want to evaluate how the investment strategy itself performed, rather than how an individual investor’s timing affected their return.
For example, suppose the portfolio performed very well during 2021–22. The investor had invested only ₹1 crore at that time. Later, after a strong rally, the investor added another ₹50 lakh. If the market subsequently corrected, the investor’s personal return would be affected because a larger amount of capital was invested before the correction. But that should not necessarily be interpreted as poor performance of the underlying strategy.
TWRR separates investment performance from the investor’s cash-flow decisions.
How does TWRR work?
The entire investment period is divided into smaller periods whenever there is an external cash flow. The return for each period is calculated separately and then geometrically linked to arrive at the overall time-weighted return.
In simple terms: TWRR asks: “How did the portfolio perform, irrespective of when the investor added or withdrew money?”
When should you use TWRR?
TWRR is useful when:
- Comparing two PMS strategies or investment managers.
- Evaluating a portfolio against its benchmark.
- Assessing investment strategy performance.
- Comparing performance across portfolios with different cash-flow patterns.
- Reviewing performance where the impact of investor cash-flow timing needs to be removed.
The investment strategy: If you are evaluating the investment strategy, TWRR provides a cleaner measure of performance.
2. XIRR – What Did I Actually Earn?
Now let’s look at the same ₹2 crore invested by our investor. The investor did not put the entire amount into the portfolio on Day 1.
Instead:
- ₹1 crore was invested initially.
- ₹50 lakh was invested later.
- Another ₹50 lakh was invested even later.
- The portfolio eventually grew to ₹3.60 crore.
This is where XIRR becomes important. XIRR, or Extended Internal Rate of Return, measures the annualised return earned by the investor after taking into account the amount and timing of every cash flow. Unlike TWRR, XIRR incorporates the investor’s timing.
Why does timing matter?
Imagine that the portfolio rises sharply after the initial ₹1 crore investment. The investor then adds another ₹50 lakh. Shortly afterwards, the market falls.
The portfolio may still have generated strong returns over the entire period. However, the investor’s actual return will be affected because a significant amount of money entered the portfolio before the fall. That impact is captured by XIRR.
The investment strategy: Two investors can invest in the same fund and have the same underlying portfolio performance, but their XIRRs can be different because they invested at different times.
How is XIRR calculated?
XIRR finds the single annualised rate at which the present value of all cash flows equals zero.
In simple terms: XIRR asks: “Considering exactly when I invested and how much I invested, what annualised return did my money actually earn?”
When should you use XIRR?
XIRR is useful when:
- Tracking your actual personal portfolio return.
- Measuring returns from SIPs or recurring investments.
- Evaluating a portfolio with multiple investments.
- Understanding the return earned on your actual capital.
- Reviewing the impact of your investment timing.
3. CAGR – How Fast Did a Lump Sum Grow?
Now we come to the metric most investors are familiar with. CAGR, or Compound Annual Growth Rate, represents the annualised rate at which an investment would have grown from its starting value to its ending value, assuming the growth was compounded at a constant rate.
The important word here is “constant.” CAGR does not tell us what happened every year. It simply converts the beginning value and ending value into a single annualised growth rate.
Formula
CAGR = (Ending Value / Beginning Value)^(1 / Number of Years) − 1
For example, if ₹1 crore becomes ₹2 crore over five years:
CAGR = (₹2 Cr / ₹1 Cr)^(1/5) − 1
= 14.87%
In simple terms: This does not mean the investment actually generated 14.87% every year. One year could have been +30%, another −15%, and another +5%. CAGR simply smooths the entire journey into one annualised number.
When should you use CAGR?
CAGR works best when you have:
- A clearly defined beginning value.
- A clearly defined ending value.
- A known investment period.
- No significant interim cash flows.
The investment strategy: This is why CAGR is commonly used to communicate the historical growth of lump-sum investments, indices, businesses and individual securities over a defined period.
One Portfolio. Three Different Questions.
The easiest way to understand the difference is to ask what question each metric is trying to answer.
| Metric | What does it answer? | Cash-flow timing | Best suited for |
|---|---|---|---|
| CAGR | How fast did the investment grow from start to finish? | Ignores interim cash flows | Lump-sum investments |
| XIRR | What annualised return did my actual money earn? | Considers timing and amount | Individual investors |
| TWRR | How did the investment strategy perform? | Removes external cash-flow impact | Portfolio and manager evaluation |
Final Thoughts: So, Which One Should You Use?
- CAGR: When evaluating the growth of a lump-sum investment with no meaningful interim cash flows.
- XIRR: When evaluating your actual return across multiple investments, SIPs or withdrawals.
- TWRR: When evaluating the performance of an investment strategy or portfolio independently of investor cash-flow timing.
The figures above are illustrative and are provided for educational purposes only. Past performance may or may not be sustained in the future.
Conclusion
The important point is that none of these metrics is inherently “better” than the others. They simply answer different questions. So, the next time you see a return number, don't just ask, “What is the return?”
Ask: “What exactly is this return measuring?”
By CA Aayush Bhatt, Head of Research & Strategy, Ascent Financial Solutions Pvt. Ltd. This article is for educational purposes only and does not constitute investment advice or a recommendation.
