Important: Timing Matters
Because investors can enter and exit at any time, at Amova we use a method (XIRR see below) that accounts for both the timing and size of each investment in and redemption out. This approach gives a fair picture of how well the investment is performing, especially when people invest or withdraw at different times.
However, XIRR is sensitive to large cash flows. If you invest or withdraw a big amount, it can distort short-term performance - either positively or negatively. Over time, this balances out.
What is XIRR and why is it important?
XIRR stands for Extended Internal Rate of Return. It’s a way to measure how well an investment has performed over time, especially when money is added or withdrawn at different points. This makes it a more accurate way to measure performance than simple averages.
Because investors can join or leave at any time, XIRR takes into account:
- When the money was invested
- How much was invested
- How long it stayed invested.
How is XIRR different from a simple average return?
A simple average return only compares the starting and ending values of an investment. It doesn’t consider when the money was invested or for how long.
For example:
- If someone invests early in the year and earns a return over three 12 months, their annualised return might be 10%.
- But if someone invests part of the investment at the start of the year and the majority half way through the year and earns the same dollar gain by the end of the year, their annualised return could be over 20%.
This shows how timing can dramatically affect performance, and why Amova prefers XIRR over simple averages.
The return I’m seeing is counter-intuitive? What’s happening with the calculation?
The XIRR calculation is essentially treating each deposit made into the investment separately, taking into account the amount of each deposit and the period it has been invested for and then it calculates a standard return number that applies in aggregate.
In most cases this aggregate return number is a good reflection on the overall performance of an investment, however, when there are large differences in the size and timing of deposits into the same investment it can produce some mathematically correct but strange results. Over time, this balances out.
A typical example would be someone who makes an initial investment to “check if it works” for, say, $100 before making a full investment of $10,000. If these deposits were made 6 months apart the performance number (covers both the $100 and the $10,000) will look strange for a period, especially right after the $10,000 has been deposited e.g. when the timeframe for that is very short.
Here’s some examples of how it plays out in different scenarios:
Case 1:
A small initial deposit of $100 and performance assessment after ~6 months. The XIRR is close to zero (-1%) because the investment barely changed in value over that period.
Case 2:
$100 invested in January as a test, then $9,900 (assumes $10,000 investment, into funds after encountering buy/sell spreads) added on July 1, and performance measurement on July 2. The XIRR shows -35.1% because the large deposit was invested for only one day, so the model assumes the large part of losses have happened on the $100 investment.
Case 3, 4 and 5:
Consider the same cash flow contributions over different periods of time – i.e. 1 week after large contribution, 1 month after large contribution and 6 months after large contribution respectively – and the key takeaway here is that as the time invested for large cash flow increases, the negative return numbers start to make more sense and by the end of the year are much more in line with investor intuition (simple average return).
Still have questions?
Reach out to our support team or your adviser. We’re happy to walk you through your personal investment timeline and explain how your XIRR was calculated.