Internal Rate of Return (IRR)

The Internal Rate of Return (IRR) is the percentage return on an investment or other income generating entity.  It includes both appreciation (price increase) and interest/dividends.  Stock charts just show price changes.  Morningstar and other Websites will show you how some amount, typically $10,000, invested at some date would have grown or shrunk up to some other date, typically today.  This is a reasonable way to evaluate stocks, bonds, mutual funds, CDs, and savings accounts.  But remember, “Past history is no guarantee of future results.”

IRR is a little more complicated.  It takes into account when and how much you have added to taken out from an investment, hence the synonym, Personal Return.  It is the annualized return, expressed as a percentage, accounting for money moving in and out.

A simple example: you invest $1000 in something (stock, mutual fund, bond, bank account) for a year, reinvesting all dividends.  At the end of the year, it is worth $1060.  This is an IRR of 6%.  If it paid quarterly dividends of $15 and you held it for 3 months, you would have the same 6% annualized IRR.

A little more complicated example that illustrates compound interest.  The same investment that pays $15 per quarter on every $1000 and you reinvest the dividend.  At the end of the first quarter you have $1015.  At the end of the second quarter you have, $1030.22 ($1015 plus 1.5% of $1015).  Third quarter end, $1045.67.  A year later, $1061.53.  IRR of 6.153%.  That extra little bit is from reinvesting the dividends instead of taking them as cash.  Note: this is exactly the difference between APR (Annual Percent Rate) and APY (Annual Percent Yield).   APY for investments is often known as Total Return.

Another common number is SEC 30 day yield which is almost always the most recent dividend multiplied by how many times it pays in a year.  E.g. last quarterly dividend times 4, last monthly dividend time 12.

Vanguard will calculate the one year IRR on investment you have held more than a year, just dig around their Website.  Quicken will calculate IRR on any of your investments for any period.  Other mutual funds and accounting packages will probably do the same.

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3 Responses to Internal Rate of Return (IRR)

  1. Monthly Dividend stocks compound faster and can really add up quickly.

  2. Fuzzythinking says:

    Hi

    Could you please expand your calculation on A – The same investment that pays $15 per quarter on every $1000 and you reinvest the dividend. At the end of the first quarter you have $1015. At the end of the second quarter you have, $1030.22 ($1015 plus 1.5% of $1015). Third quarter end, $1045.67. A year later, $1061.53. IRR of 6.153%.

    Because I could not get the same answer from my Excel:

    -1000 01/01/2016
    1015 31/03/2016
    1030.22 30/06/2016
    1045.67 30/09/2016
    1061.53 31/12/2016

    XIRR = 13.94%

    • AC says:

      You have a typo in your data. The first monetary amount should not have a minus sign. I agree, growing from $1000 in the red to $1061.53 in the black in a year is a 13% gain.

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