Both ROI and IRR measure how well an investment did. They answer slightly different questions.
Return on investment (ROI)
ROI = profit ÷ what you put in, where profit is what you got back, minus what you put in, minus all costs.
Example: you put in $10,000, got back $14,000, and paid $200 in fees. Profit is $3,800, so ROI is 38%. Over 4 years that is about 8.4% a year. Try it in the ROI calculator.
ROI is simple, but it ignores time. A 38% return in 2 years is far better than 38% in 10.
Internal rate of return (IRR)
IRR is the yearly rate of return that also accounts for when each payment arrives. It is the rate at which the cash you get back, brought to today's money, exactly equals what you put in.
Example: you put in $1,000 and get $300 a year for 5 years. You get $1,500 back, so ROI is 50%. The IRR is about 15.2% a year. Use the IRR calculator for your own cash flows.
Net present value (NPV)
NPV brings every future cash flow back to today at your target rate, then subtracts what you put in. If it is above zero, the investment beats your target. If it is below zero, you would do better at your target rate.
Which one to use
| Situation | Best number |
|---|---|
| You bought and sold once | ROI and yearly return |
| Cash comes in over several years, such as rent or dividends | IRR and NPV |
| Comparing different lengths | Yearly return or IRR |
| Comparing a result with your target rate | NPV at that rate |
Watch out for
- Costs left out. Fees, commissions and taxes cut your return.
- Reinvestment. IRR assumes you can reinvest each payout at the same rate. That is not always possible.
- Wild cash flows. If money goes in and out several times, there may be more than one IRR, or none.
- Inflation. A return below inflation does not grow your buying power.
For a stock, you can also try a DCF to see what it could be worth.
IRR and NPV calculator Work out IRR and NPV for your own cash flows.Sources
- Background reading, Investor.gov: Annual return
- Background reading, Investor.gov: Compound interest
- Background reading, Investor.gov: Compound interest calculator
This article is for education and is not financial, tax or legal advice. Figures are checked against the sources above and may change. Read the full disclaimer.