Simple Return vs Internal Return Rate (IRR)

The previous couple of years were good for your funding portfolio. Some of your mutual fund investments have performed enormously well. But knowing that your funding has doubled (i.e. Grown a 100%) is incomprehensible except you realize over what length this happened — doubling over 5 years suggests it has grown at a charge of 14.86 percent a yr, doubling over 10 years implies boom of 7.17% a 12 months, at the same time as doubling over 15 years means your funding has grown at most effective 4.73% in a 12 months.

There are two not unusual approaches to calculate gains:

Simple percentage return or return on investment: this is your holdings ' simple percentage gain over the total amount of investment, not annualized as in the calculation of the IRR. Simple return percentage works over any period of time. It simply indicates the change from time to time.

The simple percentage return is the same as the internal rate of return (IRR) below for an investment that lasts exactly one year.

Internal Return Rate (IRR): Annualized return or internal return rate (IRR) is used to show how an investment has been accomplished over time. IRR calculates the annualized percentage return irrespective of the actual investment period. Whether you're holding an investment for a year, five years, or even fifty years, it doesn't matter— the internal rate of return will tell you the annualized percentage return of that investment over any time period.

The internal rate of return is more informative to get an accurate picture of your performance over the long term or against benchmarks such as the Nifty because it describes the performance in consistent, annual terms.

How do I calculate annualized earnings or IRR?
In Excel, using the XIRR function, the easiest way to do these challenging calculations is — you need the investment dates, investment amounts and current value to be handy. The screenshots below show the cash spent on some sample investments and cash returned. To help determine our internal rate of return, we need to input the cash outflows and inflows.

Which one do you have to use?
Every calculation is useful in its own way at the end of the day. The annualized return is more informative to monitor your performance over the long term or against benchmarks such as the Nifty as it describes the performance in consistent, annual terms. However, the simple percentage return is easier to calculate to determine your earnings over a shorter period of time or to understand your cash-on-cash returns and gives you everything you need. Simple percentage gains work better for investments like equity funds with more ups and downs in the short term.Annualized percentage gains should be used for nearly everything else and more than a year over all periods of time.

Your broker, distributor or investment consultant should be able to share the annualized percentage gains (IRR) and simple percentage gains for your investment portfolio— ask both to find your true portfolio performance!