Investments are made to earn profits. And there are different ways to represent returns from an investment. Let's talk about absolute return and XIRR (aka CAGR) today -
Let's study this with an example -
Suppose you invested Rs. 1 Lakh in 2010 and it's value in 2015 is Rs. 1.5 lakhs (ie, in 5 years)
In this case,
Absolute Return = 50% (does NOT take into account the time period since you are invested)
XIRR = 8.4% p.a. (takes into account the time period since you are invested). That means, every year, you have earned a return of 8.4%. In simpler terms, in 2011, you earned INR 8,400/- (1 lakh 8.4%); 2012 you earned INR 9,105.6/- [(1 lakh + 8,400) * 8.4%] and so on to reach 1.5 lakhs in 2015.
Formula for calculating both the returns -
Absolute return = ((Current value of the investment/ Initial investment) – 1) * 100.
XIRR = ((Ending value/ Beginning value) ^ (1/n)) – 1; where n = tenure of the investment
What to use when?
If you've been investing since
Less than 1 year - Use absolute return
More than 1 year - Use XIRR
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