by Yieldstreet | Staff
When weighing different investment options to meet your financial goals, it’s important to get an understanding of your potential returns. For example, if you invest $10,000 into an online investment portfolio today, how much can you expect to earn in one year? Two years? Five years?
There are different methods investors can use to calculate the potential and actual returns of their investments. Two commonly used methods are the calculation of the internal rate of return (IRR) and the return on investment (ROI).
It’s important to ensure that when you are considering the performance of an investment, you reflect on both the target and actual IRR. For example, what exactly does it mean when you say that a particular investment has earned a 12.63% IRR? And what does it mean if you said you earned a 20% ROI over five years? In this post, we will compare IRR vs. ROI and break down what can be confusing concepts. We’ll also illustrate how to interpret IRR vs. ROI when doing your own personal due diligence on potential investments.
Return on investment or “ROI” is a metric that is often used in stock portfolios and refers to a percentage increase or decrease in a cash investment over a period of time. In simple terms, ROI is a way to measure the gain or loss created by an investment, compared to the amount that was initially invested. Essentially, it establishes the rate of return on investing for a particular opportunity.
Return on investment is fairly easy to calculate. First, subtract the original cash investment from the current investment worth. This gives you the raw dollar value increase or decrease over the course of the investment. Second, divide this number by the original cash investment. Here’s the formula:
The resulting figure is expressed as a percentage increase or decrease on the original investment.
Note that this equation does not account for how many years the investment was active. For this reason, it is important to look not only at the percentage increase or decrease (the “cash on cash return” itself), but also how many years that percentage increase or decrease took to occur. Therefore, the return on investment is best expressed as “X% [increase/decrease] over X years.” Otherwise, return on investment comparisons between different investments can be misleading because they might express gains over very different periods of time.
Internal rate of return or “IRR” is harder to calculate than return on investment. However, the internal rate of return formula has the advantage of taking into account the period of time during which investments are made.
This can make it easier to compare asset portfolios and help you choose the one that has the potential to grow your money the fastest. Usually, IRR is expressed as an annualized rate of return—the average percentage by which any outstanding principal grows during each year that your investment is maturing. In other words, IRR represents the annualized percentage rate earned on each dollar invested for each period it is invested (i.e. any money that is “outstanding” or not repaid, continues to earn the IRR at an annual rate, while any repaid principal no longer earns interest).
Let’s take a look at how to calculate IRR in order to better understand what IRR is. Unlike the return on investment formula, for most people this formula takes a calculator or Excel spreadsheet to solve if the money has been invested for more than one year:
In addition to accounting for the time during which an investment has matured, IRR addresses many other factors that return on investment does not. Unlike the return on investment calculation, IRR accounts for the amortization of an investment. While this factor makes it more difficult to calculate, it also leads many investors to view IRR as a more accurate and informative figure for evaluating investment opportunities.
IRR definitions and formulas aside, let’s look at how a hypothetical investment would perform in terms of IRR vs. ROI. For these examples, let’s assume that Yieldstreet has designated a target return of 10% on a portfolio.
To begin, let’s say you invest $10,000 into an investment portfolio. Then assume no principal repayments are made within the first three years of your investment.
After one year, your investment will be worth $11,000. Your IRR (in-year growth) is 10%. Your ROI is the same: ($11,000 – $10,000) / $10,000 = $1,000 / $10,000 = 10% over one year.
Internal rate of return and return on investment stop being equal after Year 1. Keeping in mind that interest does not compound on Yieldstreet individual investments, in Year 2, the total value of this hypothetical investment is $11,000 + ($10,000 x 10%) = $12,000. Your IRR in Year 2 is again 10%—your portfolio grew by 10% within the year. Your cash-on-cash return, however, is now ($12,000 – $10,000) / $10,000 = $2,000 / $10,000 = 20% over two years.
This pattern is the same for Year 3. Your portfolio grows by 10% again (a 10% IRR) for a total portfolio value of $12,000 + ($10,000 x 10%) = $13,000. Your return on investment is now ($13,000 – $10,000) / $10,000 = $3,000 / $10,000 = 30% over three years.
Here’s a summary of our first example:
You might notice a pattern in the above example. For the first year of investment, return on investment is the same as IRR. For every year thereafter, the gap in IRR vs. ROI grows, with return on investment consistently exceeding IRR.
However, if the principal is repaid during the duration of the investment, the principal portion that is repaid will no longer be outstanding and as a result, the repaid principal portion will not generate any additional interest.
In a simplistic example, let’s say that as of Year 2, you receive a $2,000 principal repayment. In Year 2 you would have $8,000 of remaining principal outstanding and your investment would earn $800 of interest (as the $8,000 earns the 10% IRR). However, according to the formula previously mentioned, this results in a return on investment of 8.0% for Year 2. Further, in Year 3, if you received an additional principal paydown of $3,000, the return on investment for that year is 5.0% for the remaining $5,000 of principal that remains outstanding. Finally, at the end of the full three-year duration, the total ROI is 23.0% over three years (invested $10,000 and earned $2,300 in interest), the IRR for the three-year investment remains 10%.
Unlike the return on investment, IRR considers only the money that is still actively invested and continues to earn interest at a 10.0% rate. IRR focuses squarely on the performance of your money that is still invested and does not consider the principal that has been returned. The return on investment focuses on both the performance of money still invested and money returned and makes the assumption that the $5,000 returned to the investor over the 3 years does not earn any interest.
We hope that this post has helped clarify the meaning of IRR vs. ROI distinction that you may come across when evaluating investments to find the ones that are best for you. Just remember that when you evaluate the projected “returns” on potential investments, pay attention to the terms in which those returns are expressed.
Understanding the terms in which your returns are reported is crucial to understanding how your money can be expected to grow over time in that portfolio. It is also crucial to ensure that when you weigh investment options against each other, you are truly comparing apples to apples. Remember, the same percentage figure might mean very different things depending on whether it’s expressed as IRR vs. ROI.
Sign up with your email address
Securely verify your identity and link a bank account
Verify your accreditation (if applicable) to access all of Yieldstreet’s offerings.
Our weekly podcast providing ideas about how to make money work for you and bring you closer to your dreams.
1 Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections may not reflect actual future performance. All securities involve risk and may result in significant losses.
2 Represents a net estimated, unrealized annualized internal rate of return (IRR) of your portfolio and is based by reference to the effective distribution dates and amounts to and from the investments, as well as any outstanding principal and accrued and unpaid interest as of the current date, after deduction of management fees and all other expenses charged to the investments.[read more]
3 "Annual interest" or "Annualized Return" represents an annual target rate of interest or annualized target return and "term" represents the estimated term of the investment. Such target interest or target returns and estimated term are projections of the interest or returns and or term and may ultimately not be achieved. Actual interest or returns and term may be materially different from such projections. This targeted interest or returns and estimated term are based on the underlying investments held by the applicable.
4 Reflects the initial quarterly distribution declared by the board of directors on February 6, 2020, which will be payable to stockholders of record as of June 10, 2020, and the initial offering price of $10 per share.
5 The Fund will cease investing and seek to liquidate the Fund's remaining portfolio no later than 48 months after the Fund's initial closing. It may take up to twelve months thereafter to fully monetize any remaining illiquid investments in the Fund's portfolio.
6 Represents the sum of the interest accrued in the statement period plus the interest paid in the statement period.
7 The internal rate of return ("IRR") represents an average net realized IRR with respect to all matured investments weighted by the investment size of each individual investment, made by private investment vehicles managed by YieldStreet Management, LLC from July 1, 2015 through and including Sept 6th, 2021, after deduction of management fees and all other expenses charged to investments.
8 Investors should carefully consider the investment objectives, risks, charges and expenses of the Yieldstreet Prism Fund before investing. The prospectus for the Yieldstreet Prism Fund contains this and other information about the Fund and can be obtained by emailing [email protected] or by referring to www.yieldstreetprismfund.com. The prospectus should be read carefully before investing in the Fund. Investments in the Fund are not bank deposits (and thus not insured by the FDIC or by any other federal governmental agency) and are not guaranteed by Yieldstreet or any other party.
No communication by YieldStreet Inc. or any of its affiliates (collectively, “Yieldstreet™”), through this website or any other medium, should be construed or is intended to be a recommendation to purchase, sell or hold any security or otherwise to be investment, tax, financial, accounting, legal, regulatory or compliance advice. Nothing on this website is intended as an offer to extend credit, an offer to purchase or sell securities or a solicitation of any securities transaction.
Any financial projections or returns shown on the website are estimated predictions of performance only, are hypothetical, are not based on actual investment results and are not guarantees of future results. Estimated projections do not represent or guarantee the actual results of any transaction, and no representation is made that any transaction will, or is likely to, achieve results or profits similar to those shown. In addition, other financial metrics and calculations shown on the website (including amounts of principal and interest repaid) have not been independently verified or audited and may differ from the actual financial metrics and calculations for any investment, which are contained in the investors’ portfolios. Any investment information contained herein has been secured from sources that Yieldstreet believes are reliable, but we make no representations or warranties as to the accuracy of such information and accept no liability therefor.
Private placement investments are NOT bank deposits (and thus NOT insured by the FDIC or by any other federal governmental agency), are NOT guaranteed by Yieldstreet or any other party, and MAY lose value. Neither the Securities and Exchange Commission nor any federal or state securities commission or regulatory authority has recommended or approved any investment or the accuracy or completeness of any of the information or materials provided by or through the website. Investors must be able to afford the loss of their entire investment.
Investments in private placements are speculative and involve a high degree of risk and those investors who cannot afford to lose their entire investment should not invest. Additionally, investors may receive illiquid and/or restricted securities that may be subject to holding period requirements and/or liquidity concerns. Investments in private placements are highly illiquid and those investors who cannot hold an investment for the long term (at least 5-7 years) should not invest.
Alternative investments should only be part of your overall investment portfolio. Further, the alternative investment portion of your portfolio should include a balanced portfolio of different alternative investments.
Articles or information from third-party media outside of this domain may discuss Yieldstreet or relate to information contained herein, but Yieldstreet does not approve and is not responsible for such content. Hyperlinks to third-party sites, or reproduction of third-party articles, do not constitute an approval or endorsement by Yieldstreet of the linked or reproduced content.
Investing in securities (the "Securities") listed on Yieldstreet™ pose risks, including but not limited to credit risk, interest rate risk, and the risk of losing some or all of the money you invest. Before investing you should: (1) conduct your own investigation and analysis; (2) carefully consider the investment and all related charges, expenses, uncertainties and risks, including all uncertainties and risks described in offering materials; and (3) consult with your own investment, tax, financial and legal advisors. Such Securities are only suitable for accredited investors who understand and willing and able to accept the high risks associated with private investments.
Investing in private placements requires long-term commitments, the ability to afford to lose the entire investment, and low liquidity needs. This website provides preliminary and general information about the Securities and is intended for initial reference purposes only. It does not summarize or compile all the applicable information. This website does not constitute an offer to sell or buy any securities. No offer or sale of any Securities will occur without the delivery of confidential offering materials and related documents. This information contained herein is qualified by and subject to more detailed information in the applicable offering materials. Yieldstreet™ is not registered as a broker-dealer. Yieldstreet™ does not make any representation or warranty to any prospective investor regarding the legality of an investment in any Yieldstreet Securities.
Banking services are provided by Evolve Bank & Trust, Member FDIC.
Investment advisory services are provided by YieldStreet Management, LLC, an investment advisor registered with the Securities and Exchange Commission.
Our site uses a third party service to match browser cookies to your mailing address. We then use another company to send special offers through the mail on our behalf. Our company never receives or stores any of this information and our third parties do not provide or sell this information to any other company or service.