The IRR tool calculates the annual profit an investment delivers as a percentage of the investmentâ€™s value at the start of the year. For example, in a simple case, if you buy an investment for $100 and the investment pays $10 in dividends at the end of the year and then is sold for $95, your IRR is 5 percent.
There are actually two steps to making this calculation:
Â· First, you need to calculate the annual profit. You can do this by combining the $10 of dividends with the $5 capital loss (calculated as $95â€“$100) for a result of $5 of annual profit.
Â· Second, you divide the $5 of annual profit by the $100 investment value at the start of the year. $5/$100 equals 5 percent, and thatâ€™s the IRR.
By calculating an IRR, you can quantify the performance of a stock that youâ€™ve purchased and of your investment portfolio as a whole. This is particularly true with individual stocks and brokerage accounts because you often donâ€™t really know how your stock picks.
Your brokerâ€™s picks, and your portfolio have done and are doing relative to the market as a whole and relative to other investments. In comparison, you usually have a pretty good idea as to how well a mutual fund does on a quarterly or at least an annual basis. The fund manager will report to you on the quarterly and annual returns.