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#1
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Is use of XIRR appropriate when dividends are not reinvested?
I am currently calculating internal rate of return (IRR) values for assorted
investments using Excel's XIRR function. For some investments distributions have been reinvested, whereas for others distributions have been paid out as income. Now I have repeatedly read that the IRR formula assumes that distributions are reinvested, although one source suggests that the assumption is merely that the opportunity for reinvestment exists. Several personal financial investment programs that I have looked at (MS Money and Quicken Personal Plus) clearly use the IRR formula to calculate annualised % returns whether distributions are reinvested or not. My question is whether it is appropriate to use the XIRR formula to calculate returns on investments when distributions have been taken as income and not reinvested. I'd greatly appreciate help on this. |
#2
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Is use of XIRR appropriate when dividends are not reinvested?
Certainly you can use XIRR. If dividends have been paid out in cash (rather
than reinvested), then they are a cash flow which has been received. You account for them the same as if you withdrew cash from the portfolio. Include the paid dividends in the table of cash flows, and XIRR will properly calculate the return. IRR does not assume that dividends have been reinvested. It can handle either way. What you've likely read is that when rates are published (such as for mutual funds), the published rate assumes dividends have been reinvested. Regards, Fred "Borty" wrote in message ... I am currently calculating internal rate of return (IRR) values for assorted investments using Excel's XIRR function. For some investments distributions have been reinvested, whereas for others distributions have been paid out as income. Now I have repeatedly read that the IRR formula assumes that distributions are reinvested, although one source suggests that the assumption is merely that the opportunity for reinvestment exists. Several personal financial investment programs that I have looked at (MS Money and Quicken Personal Plus) clearly use the IRR formula to calculate annualised % returns whether distributions are reinvested or not. My question is whether it is appropriate to use the XIRR formula to calculate returns on investments when distributions have been taken as income and not reinvested. I'd greatly appreciate help on this. |
#3
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Is use of XIRR appropriate when dividends are not reinvested?
Thanks for the prompt reply Fred. It is true that published rates from
mutual funds do publish that their rates assume that dividends have been reinvested, but there are definitely many references to the fact that the IRR computation does assume that distributions are reinvested. You will see this if you do a google/ yahoo search using the keywords "IRR reinvestment assumption". As I understand it that's why the modified IRR (also available in Excel) was developed. However, I wonder if the problem is only relevant to situations involving business decisions with regard to capital projects, which seems to form the basis of many discussion in regard to IRR. Any comments? "Fred Smith" wrote: Certainly you can use XIRR. If dividends have been paid out in cash (rather than reinvested), then they are a cash flow which has been received. You account for them the same as if you withdrew cash from the portfolio. Include the paid dividends in the table of cash flows, and XIRR will properly calculate the return. IRR does not assume that dividends have been reinvested. It can handle either way. What you've likely read is that when rates are published (such as for mutual funds), the published rate assumes dividends have been reinvested. Regards, Fred "Borty" wrote in message ... I am currently calculating internal rate of return (IRR) values for assorted investments using Excel's XIRR function. For some investments distributions have been reinvested, whereas for others distributions have been paid out as income. Now I have repeatedly read that the IRR formula assumes that distributions are reinvested, although one source suggests that the assumption is merely that the opportunity for reinvestment exists. Several personal financial investment programs that I have looked at (MS Money and Quicken Personal Plus) clearly use the IRR formula to calculate annualised % returns whether distributions are reinvested or not. My question is whether it is appropriate to use the XIRR formula to calculate returns on investments when distributions have been taken as income and not reinvested. I'd greatly appreciate help on this. |
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