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Author: Radish Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 3687  
Subject: Re: Tracking investment performance and Quicken Date: 7/10/2003 5:22 PM
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It's performance report gives you "average annual total return" but that is, as far as I can tell, assuming that your investment returns are extrapolated over a year's time. It doesn't give me my ACTUAL performance!

It does give you your actual performance, or to be more precise, your actual yield. Because the formula (called IRR, Internal Rate of Return, or APY, Annualized Percentage Yield) takes into consideration both the amounts of money invested AND the duration of the investments, the results may take some getting used to.

Here's an excerpt from http://boards.fool.com/Message.asp?mid=13376296 which may help:

A note about annualized returns. People often say that annualized returns are fantasy because they “project” your return so far over an entire year — and your stocks are not likely to have the same gains in the future as in the past. This is simply a misunderstanding about how to interpret the measurement. If you are driving and your speedometer says 55 miles per hour, is that speed only accurate if you continue driving at a fixed speed for an entire hour? No, the number represents your present speed, scaled for a standardized time unit.

Let's say you put $1000.00 in an ordinary bank account with daily compounding, and four months later take out $1020.10. The APY for your bank account was 6.19%. No “projection” of what “would have happened” if you'd left the money in a year is necessary: the 6.19% annual percentage yield is what you actually earned during the time the money was invested. The interest rate on the bank account was about 0.016% daily — but most likely the bank would say the interest was “6% compounded daily”, which is the annual rate. Just as it is customary to give automobile speeds based on a time unit of one hour, it's customary to give interest rates and investment returns in terms of a time unit of one year.

Another thing people frequently say about investment returns is that you should only look at your actual gain (Long-Term Gain). That's like asking your speedometer to give you your speed in miles/trip — so if you're going 55 miles per hour but your trip is only 20 minutes, your actual distance gain is 18.33 miles. The 18.33 miles number is useful information, certainly, but it doesn't tell you your speed. Similarly, with that 4-month bank account your gain was $20.10, but that doesn't tell you if you'd have been better off with a 9-month fixed-term investment with a gain of $44.10. The APY for such an investment is only 5.92% — so your bank account was better at 6.19% APY, even though the gain was less.

More posts to look at: http://boards.fool.com/Message.asp?mid=16300612

If less than a year then it is exaggerated because the IRR function requires at least one year to give a sensical average annual return.

This is not strictly true, any more than it's true that you need to drive for at least an hour before your car's speedometer can give you a sensical number of miles-per-hour.

The return calculated by IRR is not exaggerated, but it does often give numbers that are hard to believe. The reason is the volatility of the stock market is so large, that it is literally hard to believe. But that's not a fault in the measurement technique.

Phil
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