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XIRR is a pretty common term we hear with mutual fund SIPs. It is a return metric that’s used to calculate annualised returns on an investment where there are multiple cash flows at different times.
So, is XIRR only relevant for SIPs? Not really. XIRR is also used as a key return calculation metric for bond investments. In this article, we assess how XIRR is important for bonds.
What is the Meaning of XIRR?
The full form of XIRR is Extended Internal Rate of Return. It is a calculating method used to estimate returns when you invest or withdraw your money at different points in time, rather than all at once.
Most retail investors make investments/withdrawals gradually. XIRR considers these timelines to calculate the annualised return on investments based on when the money was deployed. XIRR is considered a good metric for the following types of investments:
- SIPs in mutual funds
- SWPs
- Multiple lump-sum investments
- Bonds with irregular cash flows
In bonds, this approach is relevant because:
- Some bonds may repay interest and principal in parts
- You may receive interest payments periodically
- You may buy or sell bonds at different times
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How is XIRR Calculated?
Now that you know the meaning of XIRR, let’s focus on how it’s calculated. For XIRR calculations, two things are important:
- Cash flows
Your cash flows for bond investments can include:
- Your initial investment
- Interest payments
- Principal repayments
- Date of each cash flow
Next, the timing of each payment is taken into consideration. Timing matters because money received earlier can be reinvested.
Calculating XIRR for your bond investments manually can take time and lead to errors. That’s why most investors rely on Excel or an online XIRR calculator tool to do the math. Excel uses the following formula for XIRR calculations:
| =XIRR(values, dates,) |
Here, ‘values’ is all the investments and withdrawals you make, and ‘dates’ is when each transaction happened.
Why is XIRR Important for Bond Investments?
Here’s why using XIRR for bond investments may be a good idea:
-
XIRR Shows You the Actual Realised Return
In a fixed deposit, things are simple. Your principal stays the same throughout the tenure, and both the principal and interest are usually paid together at maturity. This means your return is calculated on a consistent amount for the entire period.
But bonds work differently. In many bonds, interest is paid periodically, and the principal may also be repaid in parts over time. Because of this, the amount on which you earn interest keeps changing during the investment period.
So even if a bond shows a fixed coupon rate, your actual return may differ. This is because:
- Each time a part of the principal is repaid, future interest is calculated on a lower remaining amount
- The timing of these payments affects how long your money stays invested
- Your overall return also depends on whether you reinvest these payouts, and at what rate
XIRR takes all these different cash flows, along with their exact timing, and converts them into a single annual return. This gives you a much clearer picture of what you actually earned, instead of relying only on the bond’s quoted coupon rate.
-
It Suits Real-World Bond Investment Scenarios
When investing in bonds, a cash flow-based approach is more realistic because you might:
- Invest with lump sums in bonds at different times
- Sell bonds before the maturity date
- Receive periodic interest or partial principal repayments
All these things create irregular cash flows. So, with a simple return measure, you may not be able to capture this complexity. XIRR may be ideal for these situations since it consolidates all inflows and outflows into one number, making it easier to understand your overall performance.
When to Use XIRR Calculations for Bonds?
Here are a few instances when you can use XIRR for bonds to calculate actual returns across multiple cash flows:
- When your bond pays interest periodically
- When the principal amount is repaid in parts (instead of full repayment at maturity)
- When you buy/sell bonds at different times or prices
- When you exit before maturity
XIRR in Bonds: An Example
Now, let’s understand how XIRR in bonds works with the help of an example. Let’s say, you invest Rs. 1 lakh in a corporate bond ABC at 10% coupon rate, where repayments happen periodically instead of at maturity.
In this case, your XIRR for the bond may be calculated in this way:
| Date | Principal Repayment (₹) | Interest (₹) | Total Cash Flow (₹) | Principal Remaining (₹) |
|---|---|---|---|---|
| 03-Jul-23 | — | — | -1,00,000 | 1,00,000 |
| 05-Oct-23 | 25,000 | 2,575 | 27,575 | 75,000 |
| 05-Jan-24 | 25,000 | 1,885 | 26,885 | 50,000 |
| 05-Apr-24 | 25,000 | 1,243 | 26,243 | 25,000 |
| 05-Jul-24 | 25,000 | 622 | 25,622 | 0 |
Using Excel, your XIRR for the investment will come to 10.36%
But, this XIRR assumes that the repayments (interest+principal) you get from the investment are reinvested for the remaining tenure of the bond into another asset where the return rate matches the coupon rate, i.e., 10%.
Understanding the Limitations of XIRR for Bonds
While XIRR may be a powerful tool to measure real annualised returns, it is not a 100% perfect tool. Here are a few limitations of XIRR you should be aware of:
- It assumes the amount received (either as repayment, interest, or withdrawal) is reinvested at the same rate.
- Calculations depend on data entry accuracy.
- XIRR doesn’t show the liquidity risk or credit risk associated with the bond investment.
Using XIRR for Bonds for Clearer Returns Assessment
So now you know the importance of XIRR in bond return calculations. Since bonds involve multiple repayments of interest and principal, using XIRR is a good option to get a clearer picture of your actual annual return.
If you’re looking to invest in bonds, you can do so through the GoldenPi platform. Here, you will find a wide collection of corporate bonds, ranging from high-yield to AAA-rated bonds. So, you can easily build your fixed-income portfolio with good XIRR using these investments.
FAQs on XIRR in Bonds
1. Is XIRR a better indicator for evaluating bond returns than CAGR?
For most bond investments, yes. CAGR assumes a single investment and one exit to show you the average annual growth rate. But XIRR is better because it accounts for multiple cash flows like periodic interest and principal repayments, which is actually how bonds work.
2. What are the advantages of using XIRR for bonds?
Some advantages of using XIRR for bonds include:
- Accounts for both the timing and the amount of cash flows, giving a more accurate return estimation
- Estimate the exact yield from your investment, since most bonds pay regular interest
- XIRR can be used to estimate returns even for bonds purchased on the secondary market or those sold before maturity
3. What is an XIRR calculator?
An XIRR calculator is an online tool that helps you calculate XIRR for bonds online. These tools use contribution/withdrawal dates and amounts to calculate XIRR. Typically, this tool is available for free and can be used multiple times.
Disclaimer: This information is for general information purposes only. GoldenPi makes no guarantee on the accuracy of the data provided here; the information displayed is subject to change and is provided on an as-is basis. Nothing contained herein is intended to or shall be deemed to be investment advice, implied or otherwise. Investments in the securities market are subject to market risks. Read all the offer-related documents carefully before investing.
Fixed Deposit schemes are regulated by the Reserve Bank of India. GoldenPi Securities Private Limited is a registered debt broker and acts as a distributor and not as a manufacturer of the product.
