Internal rate of return (IRR).
In plain English
Internal rate of return is the rate that makes net present value equal zero. Put plainly, it is the annualized return an investment is expected to earn given the timing and size of its cash flows. It is solved by trial and error rather than a clean formula, which is why it lives in spreadsheets. Because it accounts for when money arrives, it handles uneven cash flows that a simple growth rate cannot. It also assumes interim cash is reinvested at the same rate, and it can produce more than one answer when cash flows flip between positive and negative.
01Why it matters
Private funds and real estate deals are marketed on internal rate of return, and the number can be pushed higher by early distributions without the total profit changing at all.
02The math, step by step
You invest $1,000 today and receive $1,300 in three years. The rate that makes those equal is about 9.1 percent, since $1,000 times 1.091 cubed is roughly $1,300. That 9.1 percent is the internal rate of return.
Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.
03What this is NOT
Total return states how much more money you ended with. Internal rate of return converts that into an annual rate that accounts for timing. Returning capital early raises the internal rate of return even when the total dollars are identical.
04Receipts
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Plain-English answers from our glossary. Receipts included. Never advice.
Educational tool. Answers come only from ClearMoneySchool's published glossary and are not advice. Why we never give advice