No. of Recommendations: 0
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.
Print the post  


When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.