KB131664 - How to calculate the annualized return in Money and in MSN Money Portfolio

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The Internal Rate of Return (IRR) is a standard accounting formula that provides a reliable way to compare the performance of different types of investments.

The return is calculated over the full date range of transactions for the investment, which provides a more realistic approximation.

The IRR is defined as the discount rate at which the present value of all cash flows related to an investment sum to zero. IRR can be equated to the bank interest rate that would give the same performance as the investment in question. Represented mathematically, the IRR is:

           ----      1
           \     ---------- * F
     0 =   /            N      j
           ----    (1+i) j
             j


where N  = number of periods (days) between cash flow number j
       j   and the start of the reporting period.

and   F  = amount of cash flow number j.
       j

and   i = internal rate of return per period (day).

Because a cash flow may occur on any day of the year, the period must be one day. Therefore, the value for i, which results from this formula must be compounded for 365 days to become an annual return.

The following items are counted as cash flow:

Cost to buy an investment: The cost basis of the investment is a negative cash flow on the day the investment is purchased.
Dividends, Interest, Capital Gain Distributions, Other Income associated with an investment: The amount of any of these items is a positive cash flow on the transaction date.
Sale proceeds: The proceeds from a sale (price multiplied by quantity, less commission) is a positive cash flow on the transaction date.
Other expenses associated with an investment: This type of transaction is a negative cash flow on the transaction date.
Default Return of Capital: The ending market value of the investment is credited as a positive cash flow on the last day of the reporting period.

Reinvested dividends or interest are not counted as cash flow. Such transactions are sum-zero from a cash flow point of view. The funds which come in from the income item are immediately used to purchase more securities. The income from the transaction affects the performance later, either as a sale or in the default return of capital item.

How to calculate the annualized return in Money and in MSN Money Portfolio

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