Absolute Returns versus XIRR

Absolute Returns versus XIRR
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XIRR (Extended Internal Rate of Return) and absolute returns serve as methodologies to evaluate investment performance, such as that of mutual funds, though they vary in terms of the information conveyed and the calculation methods employed.

Absolute Returns:
Absolute returns measure the total profit or loss incurred on an investment over a specific timeframe, expressed as a percentage. This method offers a direct evaluation of the overall performance of the investment. For instance, if a mutual fund records an absolute return of 10% over one year, it signifies a 10% gain during that period.

(Final Value – Initial Value) / Initial Value * 100

Example: Shyam invested Rs. 1,000 for a period of Four years. After four years, he got Rs. 1,500 from his investment. What is the absolute returns from his investment?

=(1500-1000) / 1000 * 100
= 50%

An absolute return measures an investment’s performance without regard to the amount of time committed.

XIRR (Extended Internal Rate of Return):

XIRR stands out as a more comprehensive metric for assessing investment performance, factoring in both the timing and magnitude of cash flows, encompassing investments and withdrawals, throughout the investment duration. It computes the annualized rate of return required to equate the present value of all cash flows (both inflows and outflows) to zero.

Date

Price

01/01/2022

-10,000

01/12/2022

-10,000

01/01/2023

-10,000

01/12/2023

-10,000

01/01/2023

-10,000

01/02/2024

90,000

XIRR

62.65%

The absolute return using the above example would be 80%. Whereas, the XIRR is 62.65%.

XIRR (Extended Internal Rate of Return) is crucial for assessing the annualized return on investment, especially in situations with irregular cash flows. It considers the timing and amounts of cash inflows and outflows, providing a more accurate measure of performance.

On the other hand, Absolute Return represents the overall gain or loss on an investment without considering the time factor. While XIRR considers the time value of money, Absolute Return offers a straightforward measure. Both metrics are vital in evaluating investment performance, providing investors with comprehensive insights into profitability, helping them make informed decisions in financial management.

In summary, Absolute return is a straightforward measure typically used for investments held for less than a year. On the other hand, XIRR (Extended Internal Rate of Return) is more suitable for investments held for over one year, especially in cases with irregular cash flows.