Quick and Dirty Method For Calculating the Internal Rate of Return For Your Investments

Let's pretend that, at the beginning of the year, your stock portfolio was worth $10,000. During the year, you did not add or withdraw any money from the portfolio. Finally, at the end of the year, your account was worth $15,000.

What was your rate of return? In this case, it is simply 15000/10000 = 1.5%, which means you made a 50% return.

But what if you added money during the year? Then, you can't simply add the additional funds to the starting value. This will understate the return because you did not have all the money working for you throughout the entire year. Instead, you must calculate your internal rate of return.

To do this accurately can require a complex calculation, but there is a quick and dirty method. This method works best when the additional funds were added in on a periodic basis throughout the year.

The method is to subtract half the additional funds from the ending value, and add half the additional funds to the starting value.

For example, we will stick to the example of a starting value of $10,000 and ending portfolio value of $15,000. But, this time we will pretend that we contributed a total of $2,000 during the year.

If we just say we turned a total of $12,000 into $15,000, we get a return of 15/12 = 25%. But, this understates the return because we did not have a $12,000 portfolio all year.

Using the quick and dirty method, our ending value will become $15,000 - $1000 = $14,000, and our starting value will become $10,000 + $1,000 = $11,000.

Thus, our estimate for internal rate of return is 14/11 = 27.27%

If we are able to use this quick and dirty method over a shorter time frame, it will be more accurate. For example, if we can determine the starting balance, ending balance and contributions for each month, we can use this formula for each month and then multiply the 12 monthly returns to get the approximate yearly return.