What is an IRR?
IRR stands for Internal Rate of Return. Although it is less familiar than terms like an interest rate, an Internal Rate of Return (IRR) is a useful way of comparing returns on different types of investment. In particular, an IRR is useful for comparing investments that pay back your capital at different times over the life of the investment and may also pay back different amounts of income over time.
Any investment, bond or loan can be represented as an IRR. An IRR calculation simply takes the investment committed at the start and the date and amount of payments returned over time. Money in your pocket today rather than tomorrow has a greater value because of the opportunity to do something else with it (whether that is reinvesting it or just spending it). IRR takes into consideration not just how much you get back, but also when you get it back.
When do we use IRR to describe your return?
An IRR can be used to describe your return for any of the investments on Abundance, but we typically show it for investments that repay your capital in instalments (rather than in one lump sum at the end) and when you’re purchasing investments on the marketplace.
In the case of an investment that repays your capital in one lump sum at maturity, we show the return as an interest rate for simplicity. For example, for an investment of £1,000 that pays £80 interest annually with capital repaid at maturity, this is shown as an 8% p.a. return. However, this investment would also be 8% IRR – there is no difference in this case.
For an investment that repays your capital in regular instalments but pays a fixed amount of annual interest, it is not possible to represent the return as a simple interest rate, instead this is shown as an IRR.
If you are looking at purchasing an investment on the marketplace, we provide an IRR calculator that shows your expected return based on the price you are considering paying. This is shown as an IRR as it takes into account the amount you are considering paying, which may be more or less than the original investment made. It also takes into account at what point within a payment period you are making your investment, as the investment may be about to pay out the interest accrued over the last 6 months for example.