Forum Archive Index - December 2001

["John H T Wilkinson" <jhtw@clear.net.nz>]

Internal Rate of Return (IRR)

 

A graph tracking the unit price over time of an investment tells us a certain amount about the investment, but it does not tell us the full story.

 

The Internal Rate of Return (IRR) on an investment brings into account the cash flows pertaining to the investment, as well as the value of the investment, so provides a more comprehensive measure how well an investment is performing.

 

I haven't tired it but, I suspect, graphing the IRR over time alongside the unit price would be an interesting exercise.

 

Duncan Balmer, in his book 'The Investment Jungle", 1988, ISBN 1 86950 252 5, Appendix F on page 225, demonstrates the IRR calculation.

 

Both Excel and Lotus 123 have an XIRR function which, when applied to a table of dates and values (I use after tax figures), allows one to easily calculated the IRR of an individual investment.

 

Now if one has a portfolio of investments and wants to see the overall IRR it seems to me that one needs to copy all the data onto another sheet, sort it into date order and then apply the IRR function to this "Total" table.

To keep calculations up to date one would have to be entering data into the tables for the individual investments and then again into the "Total" table.

 

The UNIT PRICE of the Portfolio

 

Unless cash inflows and outflows during a period have been zero, you cannot use the difference between the value of a portfolio at the end of a period and that at the start, as a measurement of how well the portfolio has done.

 

I presume that if you take the cost of the portfolio and divide it into its value you will get a Unit Price at that point in time. Is that how Unit Fund prices are calculated?

 

Can one then take this Unit Price at the start and end of a period and then use it as a measure of performance?

 

But what if you put a lump of new cash into the portfolio just before the end of the period. Would that not dilute what you are trying to measure?

 

What about distributions received. Are they deducted from the cost of the portfolio?

 

If anyone has any thoughts or comments on these matters, or can advise of any books/articles to refer to, I would very much like to hear from you.

 

Thanking you,

 

John Wilkinson