Hi Jay,

This is a particularly timely question for me as I spent the past week immersing myself in the subtleties of the Performance Benchmark Report in preparation for a presentation I gave on Saturday.

I think a lot of us tend to want to evaluate our investing efforts by asking the question,  “How much did I put into this and how much did I get out of it?”   The only problem with making the question quite that simple is that the issue of time isn’t part of it.  If I put $50 in on Jan. 1 of this year and have $100 at the end of the year,  I am having better investing success than if I put $50 in on Jan. 1 of this year and have $100 at the end of the year 5 years from now.

This is why IRR is such an interesting measure.  It is a measure of rate of return.  It tells me how well or how “quickly”  I’ve made my investments grow.  

I find it useful to think of IRR as what I refer to as a “Magic CD” rate.  It’s as if, each time cash went into my club during the time period in question, I had a CD available that payed the IRR rate of interest and I invested my money in it.   Today, the value of my club is the sum of the values of all those CD’s.       

Each influx of money grew at the IRR rate for however long it was invested.

Your job as investors, is to make investing decisions which will keep your IRR at an attractive rate.   What is an attractive rate?  I think we’d agree that it’s a rate that’s higher than you could earn by investing your money elsewhere.  That’s why we do “benchmarking”.   You can easily compare your club’s IRR to CD rates at your local bank.  Hopefully you are achieving better returns than you would have if you had put your contributions into them.  But,  it’s also interesting to see whether you’re able to make your contributions grow faster in your club than just putting them into a different investment, for example an index fund.

This is what the bivio Performance Benchmark Report tells you.   For a given time period and your exact cash flows,  it tells you your Club IRR and the IRR you would have achieved if you had put your money into a different investment.     This is a true apples to apples comparison of “how you are doing” and I encourage you and all clubs to keep an eye on the feedback the report gives you.

 Laurie Frederiksen

 www.bivio.com

Hi Jay,

This is a particularly timely question for me as I spent the past week immersing myself in the subtleties of the Performance Benchmark Report in preparation for a presentation I gave on Saturday.

I think a lot of us tend to want to evaluate our investing efforts by asking the question,  “How much did I put into this and how much did I get out of it?”   The only problem with making the question quite that simple is that the issue of time isn’t part of it.  If I put $50 in on Jan. 1 of this year and have $100 at the end of the year,  I am having better investing success than if I put $50 in on Jan. 1 of this year and have $100 at the end of the year 5 years from now.

This is why IRR is such an interesting measure.  It is a measure of rate of return.  It tells me how well or how “quickly”  I’ve made my investments grow.  

I find it useful to think of IRR as what I refer to as a “Magic CD” rate.  It’s as if, each time cash went into my club during the time period in question, I had a CD available that payed the IRR rate of interest and I invested my money in it.   Today, the value of my club is the sum of the values of all those CD’s.       

Each influx of money grew at the IRR rate for however long it was invested.

Your job as investors, is to make investing decisions which will keep your IRR at an attractive rate.   What is an attractive rate?  I think we’d agree that it’s a rate that’s higher than you could earn by investing your money elsewhere.  That’s why we do “benchmarking”.   You can easily compare your club’s IRR to CD rates at your local bank.  Hopefully you are achieving better returns than you would have if you had put your contributions into them.  But,  it’s also interesting to see whether you’re able to make your contributions grow faster in your club than just putting them into a different investment, for example an index fund.

This is what the bivio Performance Benchmark Report tells you.   For a given time period and your exact cash flows,  it tells you your Club IRR and the IRR you would have achieved if you had put your money into a different investment.     This is a true apples to apples comparison of “how you are doing” and I encourage you and all clubs to keep an eye on the feedback the report gives you.

 Laurie Frederiksen

 www.bivio.com

Hi Leo,

I gave the presentation at the Mid Michigan BetterInvesting Regional conference that was held this past Saturday.

I have posted it here:

www.bivio.com/hn/benchmarking-your-portfolio.pdf

I will probably do it as a webinar also.  If I can find back room helpers, perhaps on May 15 when I can combine it with the drawing for the free subscription for our “gold star” clubs.

I am an engineer also and that’s why I struggled when I really focused on what IRR is all about and what I could do with it.  While mathematically I can understand that it’s “the discount rate which makes the net present value of all the cash flows zero”,   I still needed to figure out what I could do with that information that would help me with my investing activities.

That is why I ended up thinking of IRR as a “magic CD” rate.     It is a rate of return I received each time I made an investment in my club during the period I am looking at.  I find this an easy idea for me to relate to to decide how successful I’m being at making investing decisions.   

It’s easy for me to understand whether I’ve done better by putting my money into my club than into  CD’s  and it’s interesting to have a way to make a true apples to apples comparison about whether I am doing better than just putting the same money into an index fund.

With this information,  I can understand whether I should keep doing what I’m doing or make changes to my methodology.

If your club is not doing as well as the benchmark,  I don’t think that is a reason to despair.  A club is a learning (as well as social) activity.  What is probably more interesting to follow is the change in your relative rate of return (the difference between the club and the benchmark IRR’s).   I was very surprised when I plotted this for my own club for the last two years to see a graph like this:

What I like about this graph is the trend line.  Believe me,  it hasn’t always looked this nice but it does appear like we are making improvements in something we are doing when we choose our investments.

I know we would all like a simple calculation where we take what we end up with and subtract what we have contributed to determine how we’re doing.   The problem with this is that it does not take the time value of money into account and can mislead us into thinking we are doing better or worse at making investing decisions than we really are.

Investing decisions should be made by being focused on optimizing your rate of return going forward.  Too often,  they are made by looking at historical gains and losses with no sense of the time frame involved in producing them.   By focusing on your IRR and making decisions that appear as though they will optimize your rate of return,  your overall or total return should take care of itself.

This is one of the fundamental thoughts behind the ManifestInvesting methodology.  Manifest Dashboards are not a snapshot of how you’ve done,  they are a projection of how you might do with a given portfolio of investments.  If you keep your eye on optimizing your portfolio PAR,  you will always be focusing on thinking about the future, not the past.

You also have good questions about the IRR report for specific investments and I owe Lynn an answer on that also.  It is a different subject so rather than try and pile in too much information here,  I will address it in a future post.

Laurie