Key Takeaways
- The tool can help investors decide between investments of unequal sizes and can modify the assumed reinvestment growth rate at different project stages.
- An internal rate of return (IRR) is the annual growth rate an investment is expected to generate.
- Modified internal rate of return (MIRR) is a way of calculating the return on an investment that has irregular, multiple cash flows.
All investors like an edge, anything that can potentially help produce the greatest returns possible. Enter the modified internal rate of return (MIRR). While no investment is without risk, this key tool can help investors improve their investment strategy and make smarter, more informed financial decisions. Here is how — and more.
MIRR and its Importance
In simple terms, modified internal rate of return is a way of calculating the return on an investment that has irregular, multiple cash flows. It is a variation of the more commonly used standard internal rate of return (IRR).
MIRR is an important metric that can help investors decide between investments of unequal sizes and can modify the assumed reinvestment growth rate at different project stages. This means the financial measure can play a key role in financial decision making.
When making a capital investment, the move is generally considered solid if the project’s MIRR exceeds the expected return on investment (ROI). If the opposite is true, the investment is considered unfavorable. In other words, when deciding between two projects, we believe the investor should generally go with the one with the highest MIRR.
How to Find MIRR
When it comes to how to find MIRR, the steps require details regarding cash flows as well as the finance and reinvestment rates, and the number of periods.
To illustrate, say a person has a $200,000 investment that is expected, in the first year, to generate $50,000. The investment is expected to produce $100,000 the following year and then keep increasing by $50,000 annually up to the end of the fifth year.
At 10%, the reinvestment rate matches the financing rate, and the negative cash flow is $200,000. Thus, the modified internal rate of return totals 33.8%, which is generally considered a sound investment.
MIRR Formula
The equation can be complicated and tedious to execute, which is where financing software or MIRR calculators can come in handy for automation.
In any case, the formula in Excel is =MIRR (cash flows, financing rate, reinvestment rate)
Where:
- Cash flows represent individual cash flows from each series period
- Financing rate represents borrowing costs, or the interest expense Should there be negative cash flows
- Reinvestment rate is the compounding rate of return at which positive cash flow is reinvested.
In an example, here are the assumptions about two projects, both of which receive the same amount of cash over the investment’s life. They show how the MIRR differs from the IRR, which is discussed in detail later:
— Both have initial investments of $1,000
— Both have positive cash flows of $1,750
— Timing of cash flow is the final year for Project A and the first year for Project B
— The MIRR’s reinvestment rate is 0%.
In Project A, both the IRR and MIRR are at 8%. In Project B, the IRR is 75% while the MIRR is 8%.
Limitations of MIRR
The MIRR can be an extremely effective tool for helping investors decide between unequal investments. It also permits them to change the assumed reinvestment growth rate at every project stage.
However, there are limitations — namely, that the measure requires the use of assumptions and estimates. But then, as many point out, there are no 100% certainties in the investment space.
Another potential limitation is that the MIRR is not as widely used as the IRR. Thus, using the former may call for more explanation to banks and corporations and the like.
IRR vs. MIRR and Real Estate
The IRR is the annual growth rate an investment is expected to generate.
The chief concern with IRR is that it assumes the reinvestment of positive cash flows at the same rate. The MIRR is a modification of the IRR — it factors in the external rate of return. Thus, it is generally thought to be a more accurate representation.
However, when deciding which metric to employ in commercial real estate (CRE), for example, the investor’s goals as well as the investment’s context must be considered. In some cases, the traditional IRR may be more accurate than MIRR.
The main differences between the two:
- The IRR often offers multiple solutions, which can be ambiguous for investors. By contrast, MIRR provides a single solution that is generally viewed as a more realistic picture of the project’s ROI.
- With MIRR, the project’s ROI is frequently lower than the IRR, albeit usually more accurate.
- Also, the MIRR is less known than the IRR. That may call for more buy-in efforts and explanations to involved parties.
Whichever metric is used, real estate remains a popular investment as a way to generate income and grow wealth.
There are a number of ways to enter the market, most of which require a good deal of knowledge and know-how. Or, investors can go through Yieldstreet, one of the leading alternative investment platforms on which $4 billion has been invested to date as of 2/29/24. Yieldstreet’s offerings are not only accessible but are highly vetted before they make the platform.
Yieldstreet’s opportunities include real estate equity for Individual Retirement Account investors. The company has closed more than $900 million in commercial real estate transactions across over 100 deals.
Another good reason to invest in real estate is for portfolio diversification. Constructing a portfolio containing a mix of asset types and anticipated performances can not only help protect against inflation and potentially improve returns, but it can also help mitigate overall risk. In fact, we believe diversification is a crucial element of long-term investing success.
Alternative Investing and Portfolio Diversification
Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.
However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other alternative investments.
Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.
Learn more about the ways Yieldstreet can help diversify and grow portfolios.
Summary
Despite its limitations, investors can use MIRR to rank investments or projects of unequal size and choose between them. The tool can also alter the assumed rate of reinvestment growth at different stages of an investment project. Thus, MIRR can play a key role in financial decision making.
Remember how MIRR compares with IRR, and how they are used in real estate, which can diversify investments.
What's Yieldstreet?
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.
2 Represents an net annualized return, using an internal rate of return (IRR) methodology, with respect to the matured investments shown in your Portfolio experience, utilizing the effective dates and amounts of subscriptions and distributions to and from the investments, net of management fees and all other expenses charged to the investments.[read more]