How to Calculate Your True Investment Returns (XIRR Explained)

You check your portfolio and see it's up 15% this year. Great news, right? But wait—you also added money throughout the year. Is that 15% truly your investment skill, or just the result of adding more cash? This is where understanding the difference between simple returns and XIRR becomes crucial.

The Problem with Simple Returns

Simple return calculations look at where you started and where you ended:

This works fine if you invest once and never touch the money. But that's not how most people invest. We add money regularly, withdraw occasionally, and the timing of these cash flows dramatically affects our true returns.

What is XIRR?

XIRR stands for Extended Internal Rate of Return. It calculates your annualized return while accounting for the exact timing of each cash flow—every deposit, withdrawal, and the final portfolio value.

A Practical Example

Let's look at a real scenario to see how dramatically these methods can differ:

Simple Return Calculation

Total invested: €20,000
Final value: €22,000
Simple return: (22,000 - 20,000) / 20,000 = 10%

XIRR Calculation

XIRR takes into account that your January money had 12 months to grow, your July money had 6 months, and your November money had only 2 months. Using XIRR calculation:

XIRR = 14.2% annualized return

The XIRR is actually higher than the simple return in this case because most of your gains came from money that was invested for the full year.

When XIRR Tells a Different Story

Consider the opposite scenario: you invest heavily right before a market drop, then the market recovers. Your simple return might look positive, but your XIRR could be negative because your largest investments experienced the decline.

Money-Weighted vs Time-Weighted Returns

You might also hear about Time-Weighted Return (TWR). Here's the difference:

• XIRR (Money-Weighted): Shows how your actual money performed, including the impact of when you added or removed funds. This is what matters for your personal wealth.
• TWR (Time-Weighted): Eliminates the effect of cash flows to show pure investment performance. This is how fund managers are typically evaluated since they don't control when investors add or withdraw money.

For individual investors tracking personal portfolios, XIRR is usually more relevant because it reflects your actual experience.

How to Calculate XIRR

XIRR is complex to calculate by hand—it requires iterative methods to solve. Fortunately, you have several options:

1. Spreadsheet Functions

Both Excel and Google Sheets have built-in XIRR functions. You provide a list of values (negative for investments, positive for the final value) and their corresponding dates.

2. Portfolio Tracking Apps

Modern portfolio trackers calculate XIRR automatically. When you log your transactions with dates, the app handles all the math and shows your true annualized return.

3. Online Calculators

Various free online tools let you input your cash flows and calculate XIRR, though manually entering years of transactions can be tedious.

Common Mistakes to Avoid

• Forgetting dividends: If you receive dividends as cash (not reinvested), they should be recorded as positive cash flows on their payment dates.
• Wrong signs: Investments you make should be negative (money leaving your pocket), while the final value and withdrawals should be positive.
• Missing transactions: Every deposit and withdrawal affects the calculation. Incomplete records give inaccurate results.
• Incorrect dates: XIRR is sensitive to dates. Using approximate dates can skew your returns.

What's a Good XIRR?

Your XIRR should be compared against relevant benchmarks:

• Inflation: At minimum, you want to beat inflation (2-3% in most developed economies) to preserve purchasing power.
• Risk-free rate: Government bonds offer the “risk-free” return. Your XIRR should exceed this for taking on investment risk.
• Market index: Compare against a relevant index like the S&P 500 or MSCI World. If you're consistently underperforming, consider index funds.

Conclusion

Understanding XIRR transforms how you evaluate your investment performance. It moves you beyond simplistic “I invested X and now have Y” thinking to a more sophisticated understanding of how your money actually performed.

The key takeaways:

• Simple returns ignore timing and can be misleading
• XIRR accounts for every cash flow and its exact date
• Use XIRR to evaluate your personal investment decisions
• Keep accurate records of all transactions with dates
• Compare your XIRR against appropriate benchmarks