Actually, I got my Quicken computer faster than I expected. And it appears that both you and I are right. :)
You are right that I was mistaken and Quicken (at least Quicken 2007) uses formula that accounts for most of the issues I described. So, yes, you can use it to measure your IRR even with inflows and outflows. Maybe. :) Since there are still important caveats.
Assume the situation as before: you have $1000 in stocks in the account. You sell your car and deposit $10000 into account and remove it couple days later to buy a new car. It has not earned anything in the account. Still this couple day period that did not earn anything reduces your IRR. Not as significantly as I claimed before, but it still does. And it will reduce the IRR the longer you hold cash and the longer it does not earn anything.
It is working as intended, but if you use an investment account to hold cash - as I do - this cash will distort your IRR. Of course, the alternative would be to put cash into investment account exactly when you buy stocks and remove it exactly as you sell them. From what I understand if you set up your investment account in Quicken as linked to cash account, Quicken uses this accounting. This would increase your IRR and one could argue that this distorts the situation too. E.g. BRKA's return would be much higher if they could do such accounting. ;)
There is still an issue that significant short term investments will distort the IRR too. Assume situation as before: $1000 in stocks. Someone gives you a tip and you buy calls for $10000. If you sell them in 2 days for $11000, your IRR for the year will be over 100%. If you sell them in 2 months, your annual IRR will be <50%. Again, both of these numbers are correct per formula and per some common sense. But IMHO both of them are also very misleading.
What is even more misleading is that Quicken's calculation of IRR depends on interaccount dependencies. If, in the example above you start with $11000 in the account and perform all your purchases and sales inside the account, Quicken will just use the beginning value and the end value of the account for IRR and will practically use simple formula End/Beginning. However, if you get the cash into account and remove it later, the IRR may change dramatically to take into account the dates when cash was added and removed.
So thanks for your suggestion to double check my assumptions. :) But I still believe that Quicken's calculation of returns for accounts with inflows and outflows is wrought with a lot of hidden caveats. Tread lightly. :)
Happy New Year. |
