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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: Quicken's Rate of Return incorrect Date: 4/22/1998 10:45 PM
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yFool, I don't think you're quite understanding my point; I probably wasn't as clear as I should have been.

I'm saying, assume I find a bank somewhere that pays annually compounded interest on say, a savings account. (I know that's improbable, but Quicken picked annual compounding, not me.) And, their annual interest rate is 200% (I know that's improbable too, but it makes the error so much clearer).

OK, you've got this savings account with 200% interest compounded annually. You put $1000 in on January first. After half a year, you close the account out. I agree that there has been no compounding, because you didn't wait the whole year out. So, does the bank give you back your $1000 and say "have a nice day"? Not any bank I know of. They would pay you the accrued interest, which would be $1000 x 200% x 1/2year, or $1000 (plus your original investment of $1000, for a total of $2000).

So, we know that with a 200% annually compounded savings account, you put in $1000 and half a year later you get out $2000 (if you close the account). You enter these results in Quicken (using "buy" and "sell" an imaginary security), and ask it what the annually compounded interest rate was. Quicken's help text specifically says it computes the interest rate that a bank would pay in order to give the same return as your investment, which we know is 200%. But Quicken's result is 300% (give or take a little).

My assertion is that since the help text says it computes the interest rate you'd have to make from a bank to match the results of your investment, the 300% answer is wrong.

It's a little harder to judge Excel's XIRR function, since they never say exactly what it's supposed to compute anyway. But I think I could demonstrate that XIRR gives conflicting answers, given enough text space (Microsoft believed me, anyway, and it took a heck of a lot of text).

As to your comment that if $1000 went to $2000 in half a year, the $2000 would go to $4000 by the end of the year, no, that's not true. The account is going to be compounded annually (that is, by the end of the year, still no compounding will have taken place). At mid-year, there's $1000 in principal and $1000 in accrued (but not compounded) interest; in the second half of the year additional interest will accrue on the $1000 principal only, not on the principal plus accrued interest.
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