Most of the clients in financial world refers to two terms IRR and ROR for the fund and there is a calculation formula for the same.

What is the difference between these two terms and where and why it matters?

  • 1
    Do you have a specific context that made you use the hedge funds tag? – D Stanley Feb 28 '17 at 21:03

There may be differences in different contexts, but here's my general understanding:

Rate of Return (or Return on Investment) is the total gain or loss of an investment divided by the initial investment amount. e.g. if you buy stock for $100 and later sell it for $120 you have a 20% Rate of Return. You would have a 20% ROR regardless of if you sell it tomorrow or in a year.

Internal Rate of Return is effectively annualized. It is the annual rate at which each of a series of cashflows is discounted that would give you a net present value of 0. Meaning if you spent $100 today and in exactly one year you received $120 back, you would have an IRR of 20%. If you received the $120 back in 6 months, your IRR would be roughly 40%.

An IRR calculation can include multiple cashflows at various times, while ROR is (in my mind) the total net gain or loss relative to the investment (irrespective of the time of the cash flows).

IRR is more effective when comparing investments that have different time horizons. Spending $100 to get $120 tomorrow is much better (from an IRR perspective) than getting $120 two years from now, since you could take that $20 gain and invest it for the rest of the two years.

| improve this answer | |

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.