Internal rate of return… the new math
Performance measurement is a critical part of the investment management process.
It helps identify whether the performance of your personal investments are on track.
Until recently, Modified Dietz was the industry’s favoured
method for calculating personal rates of return, largely
because it’s a simple calculation. However, the Modified Dietz
calculation takes mathematical shortcuts, which means it can
only estimate the true money-weighted rate of return.
personal basket of investments has actually performed –
it simply provides you with a clearer picture of your
performance results.
Internal rate of return… a clearer equation
When comparing your historical rates of return, which used
the Modified Dietz calculation, with your new reports that
use the IRR method, you may see differences in the results.
Any such discrepancies are reflective of the two different
calculation methods only. In this situation, it is important
to understand that there has been no change in the
underlying value of your investments. For example, when
no deposits, withdrawals or transfers are present in your
account, the IRR calculation will be no different than the
Modified Dietz calculation.
In contrast to the Modified Dietz calculation, an Internal rate
of return (IRR) calculation does not estimate. It is a more
complex mathematical calculation that provides you with a
precise personal rate of return. For these reasons, Canadian
securities regulators now require IRR to be used as the new
industry-wide standard for calculating personal rates of return.
What you need to know about the change to IRR
The shift to an IRR calculation doesn’t change how your
Comparing results: Modified Dietz
vs. IRR calculations
MANULIFE SECURITIES INCORPORATED OR MANULIFE SECURITIES INVESTMENT SERVICES INC.
Below we have provided you with three scenarios of what you can expect to see when
comparing past rates of return, based on the Modified Dietz calculation, with your rates
of return calculated with the IRR method:
EXAMPLE 1:
Account starts with $20,000 and there are no
deposits, withdrawals or transfers.
As mentioned earlier, when no deposits, withdrawals or
transfers are present in the account, the IRR calculation
will be no different than the Modified Dietz calculation.
40,000
40,000
40,000
30,000
30,000
30,000
20,000
20,000
20,000
10,000
10,000
10,000
00
0
EXAMPLE 2:
Account starts with $20,000 and there is a
$100 deposit every month for 5 years.
When small deposits, as compared to the beginning
balance are introduced to the account, the difference
between the IRR calculation and the Modified Dietz
calculation will be negligible.
Beginning
Beginning
Balance
Beginning
Balance
Balance
Year
Year 11
Year 1
Year
Year 22
Year 2
Year
Year 33
Year 3
Year
Year 44
Year 4
Year
Year 55
Year 5
Ending
Ending
Balance
Ending
Balance
Balance
IRR = 9.1%
Modified Dietz = 9.0%
40,000
40,000
40,000
30,000
30,000
30,000
20,000
20,000
20,000
10,000
10,000
10,000
00
0
EXAMPLE 3:
Account starts with $20,000 and there is a
large $10,000 deposit every year for 5 years.
We can see that because of the mathematical shortcuts
inherent in the Modified Dietz calculation, it has a more
difficult time estimating the true personal rate of return,
particularly when large deposits are introduced
(as compared to the beginning balance). Conversely,
the IRR calculation more properly accounts for these large
deposits and calculates the true personal rate of return.
IRR = 9.0%
Modified Dietz = 9.0%
Beginning
Beginning
Balance
Beginning
Balance
Balance
Year
Year 11
Year 1
Year
Year 22
Year 2
100,000
100,000
100,000
Year
Year 33
Year 3
Year
Year 44
Year 4
Year
Year 55
Year 5
Ending
Ending
Balance
Ending
Balance
Balance
IRR = 9.5%
Modified Dietz = 9.1%
80,000
80,000
80,000
60,000
60,000
60,000
40,000
40,000
40,000
20,000
20,000
20,000
00
0
Beginning
Beginning
Balance
Beginning
Balance
Balance
Year
Year 11
Year 1
Year
Year 22
Year 2
Year
Year 33
Year 3
Year
Year 44
Year 4
Year
Year 55
Year 5
Ending
Ending
Balance
Ending
Balance
Balance
The bottom line
The move to an IRR calculation provides you with a clearer, more precise view of your personal rate of return, enabling you to
better understand the value of your investments and whether you are on track to meeting your goals.
For more information,
please contact your advisor.
This material has been prepared to provide information on the products and services offered through your Manulife Securities Incorporated (MSI) or Manulife Securities Investment Services Inc. (MSISI) Advisor.
Manulife Securities is a Trade Name used by both of the related companies MSI (an Investment dealer) and MSISI (mutual fund dealer). Please confirm with your Advisor which company you are dealing with for each
of your products and services. Stocks, bonds and mutual fund products and services are offered through MSI, Manulife Securities Incorporated is a Member of the Canadian Investor Protection Fund and a Member
of the Investment Industry Regulatory Organization of Canada. Mutual fund products and services are offered through MSISI, Manulife Securities Investment Services Inc. is a Member of the Mutual Fund Dealers
Association of Canada and the MFDA Investment Protection Corporation (excluding Quebec). Manulife, Manulife Securities, the Block Design, the Four Cube Design, and Strong Reliable Trustworthy Forward-thinking
are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under licence.
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