IRR to overall return
Hello everybody, sorry to be a jerk ...I mean first post on the forum and that too a question..but I couldn't find a straight answer anywhere so here it is
My understanding is that IRR is internal rate of return (i think it gives annualised return for everydollar (internally invested- used with where periodic payments have been made) and I also understand that total return is different as it gives total return on the dollar figure. Anyways how can i convert -3.78 per annum IRR for the period 3rd may 2007 to 15 july 2010 into overall return for the period? is there a excel formula?
and while we are at it..what the hell is average IRR? OR average XIRR? THANKS IN advance
IRR and total return, while giving broadly similar information, are fundamentally different metrics.
When you look at total return, you're essentially calculating what your investment at time 0 produces by the end of the investment. This can be annualized using the CAGR formula. An ideal use of the total return metric is when you invest, say, $100 into a stock at time 0 and it increases in value to $115 in time 2 when you sell. You calculate a total return of 15% and then use the CAGR formula to calculate an equivalent annual return.
IRR, however, is more of cash flow metric. It's literally impossible to calculate a total return from the IRR information you gave without knowing at which point during the investment cash flows went in and out. IRR isn't meant as a tool for calculating total returns. It's meant as a tool for investment decision making when there are cash flow considerations.
This is right. XIRR is used to calculate the IRR at using a variable date stream, typically monthly or quarterly. I don't know that I've ever seen average IRR, I guess be used to average various investments, although you should roll these up and calculate a single IRR to properly account for timing differences.
First of all thank for your response. What you have written makes sense but I was just wondering that if IRR is annualised rate of return i.e for the whole year and the relevant period from 3/5/2007 to 15/07/2010 is 3.20274 years, is there a way to calculate the actual total return on this basis for example for 3 years if IRR says -3.78 then 3*3.78 =11.34 plus -0.766% for last 74 days total comes to -12.10% but somehow I think this is not write because IRR also factors in compounding? Or should I used this formula to cover annualised IRR to YTD ( for the last 74 days) (1+0.0378)74/365 - 1. = 0.76% and this would mean add 11.34+ .76% = 12.10%
Is this correct? Or I am completely lost?
Here's the thing--IRR really isn't an annualized rate of return, which is where you're getting confused. I'm not sure if a professor gave you this question and you have to figure out some form of answer, but the answer is that IRR isn't an annual rate of return. IRR is a function of NPV and utilizes an assumption that cash flows during an investment period are reinvested at the internal rate of return (which isn't a realistic assumption in many cases). Because of reinvestment assumptions, your IRR will usually be higher than your compound annual rate of return (or lower if you're re-investing at losses).
Example:
Time 0 you invest $100 Time 1 you get $5 in cash flow Time 2 you get your $100 back
IRR assumes you re-invest the $5 of positive cash flow into an investment with the same IRR. So if your computer program ran the IRR to, say, 15% (NOT using the example above) then the computer, through an iterative process, found that the $5 positive cash flow was reinvested at a 15% annual return. So really, the IRR isn't an annual rate of return. It's the number that sets your project NPV to 0 and is used, ideally, to compare two projects with similar timeframes.
So the REAL answer is that the -3.75% IRR you have can't be used to calculate a total return. The only way to get a total return would be to set aside your IRR and to look at the actual investment--what dollars went in, when, and what came out and when. You can't create a total return solely out of IRR information. You need more data.
Thank you so much for taking time out to explain this. I was asked this question and I was not sure how best to answer. The situation is that for the time frame of 3.20274 years the XIRR gave -3.78 as answer and I think the person who wants to use is wanted to apply this -3.78 but when I ran some simulations I got confused as first to which amount this return should be used because there were few deposits made to this portfolio!! and then to top it of when I looked at roi which was Total funds received (income + sale) $700,129.41 Total funds paid/contributed -$754,854.0 with the net effect of -$54,724.64 and this comes to -7.25 %and when I tried to roll back 3.78 it was coming to 12.. something and when I ran all the transactions into this software of ours it came back as 11.62% as total return and 3.87 (which matches ours) So I still cant understand why total return would be different as in 11.62 vs 7.25
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