👋 XIRR vs IRR: What’s the difference?
📈 XIRR vs IRR: What's the difference?
XIRR and IRR are used to find the IRR of a project.
But what is the difference between them?
The XIRR and IRR functions in Excel are nearly identical besides one critical difference:
✔️ Timing Assumptions
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The IRR formula assumes there are equal time periods of a year between the cash flows of a project.
The XIRR formula is much more flexible and is based on the dates of the cash flows for the project.
Bottom Line: We recommend using XIRR.
I asked Chatgtp what the differences were and got this reply:
XIRR (Extended Internal Rate of Return) and IRR (Internal Rate of Return) are both methods used to calculate the rate of return on an investment, particularly in the context of real estate investments. Here's the difference between them:
- IRR (Internal Rate of Return):
- IRR calculates the rate of return on an investment based on a series of cash flows occurring at regular intervals. It assumes that these cash flows happen at the end of each period (e.g., annually or monthly).
- IRR does not consider the actual dates of the cash flows; it only considers the amounts and the timing (periods) of those cash flows.
- It's commonly used to evaluate the profitability of investments where cash flows are predictable and occur at regular intervals, such as fixed-income investments or projects with evenly spaced cash flows.
- XIRR (Extended Internal Rate of Return):
- XIRR is an extension of IRR that can handle irregular or non-periodic cash flows. It takes into account the actual dates of each cash flow, making it more accurate for investments with uneven cash flow patterns.
- XIRR considers both the amounts and the specific dates of the cash flows when calculating the rate of return.
- It's particularly useful for evaluating the returns on investments like real estate, where cash flows can vary significantly in amount and timing (e.g., rental income, property appreciation, expenses, etc.).
In summary, while both IRR and XIRR are used to calculate rates of return on investments, IRR assumes regular intervals for cash flows, whereas XIRR handles irregular or non-periodic cash flows by considering the actual dates of each cash flow. For real estate investments with irregular cash flows, XIRR is generally preferred for its accuracy in measuring the true rate of return.
Quote from @Kathleen Osborne:
I asked Chatgtp what the differences were and got this reply:
XIRR (Extended Internal Rate of Return) and IRR (Internal Rate of Return) are both methods used to calculate the rate of return on an investment, particularly in the context of real estate investments. Here's the difference between them:
- IRR (Internal Rate of Return):
- IRR calculates the rate of return on an investment based on a series of cash flows occurring at regular intervals. It assumes that these cash flows happen at the end of each period (e.g., annually or monthly).
- IRR does not consider the actual dates of the cash flows; it only considers the amounts and the timing (periods) of those cash flows.
- It's commonly used to evaluate the profitability of investments where cash flows are predictable and occur at regular intervals, such as fixed-income investments or projects with evenly spaced cash flows.
- XIRR (Extended Internal Rate of Return):
- XIRR is an extension of IRR that can handle irregular or non-periodic cash flows. It takes into account the actual dates of each cash flow, making it more accurate for investments with uneven cash flow patterns.
- XIRR considers both the amounts and the specific dates of the cash flows when calculating the rate of return.
- It's particularly useful for evaluating the returns on investments like real estate, where cash flows can vary significantly in amount and timing (e.g., rental income, property appreciation, expenses, etc.).
In summary, while both IRR and XIRR are used to calculate rates of return on investments, IRR assumes regular intervals for cash flows, whereas XIRR handles irregular or non-periodic cash flows by considering the actual dates of each cash flow. For real estate investments with irregular cash flows, XIRR is generally preferred for its accuracy in measuring the true rate of return.
IRR is for when you have consistent payment stream and no expenses- for example a government bond.
XIRR is when you have variation of cashflows. For example we invest in mortgage notes which we use XIRR since we have costs and income that are not the same day or consistent throughout the year.
IRR itself is the interest rate you pay yourself to get to a specific number. For example if I have $10,000 today, and I want it to be $100k in 6 years, what interest rate compounded will I need to get there. That is IRR.
NOTE: IRR assumes reinvestments are at the same original rate so that can throw off projections, also short term assets can have large swings in IRR due to it takes into consideration time.
Lastly where IRR is extremely helpful is when analyzing two deals.Such as should I buy and hold this asset for 3 years, 5 years or fix and flip it or comparison of two separate investments. I love talking finance so feel free to hit me up with questions