What is a realistic return on value investing?

[swakoo]

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Without going into the mechanics of how XIRR works, it struck me that it's doing computations based on cash inflow and outflow. That means the current market value of your stocks (not sold ones) is not taking into consideration.

If my thinking is correct, that means we may be able to show a super positve XIRR by only realising profits but not losses?

The current market value of stocks (not sold yet) should be included in the first column and marked to today's date, and it'll all be kosher.

[KopiKat]

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Without going into the mechanics of how XIRR works, it struck me that it's doing computations based on cash inflow and outflow. That means the current market value of your stocks (not sold ones) is not taking into consideration.

If my thinking is correct, that means we may be able to show a super positve XIRR by only realising profits but not losses?

The current market value of stocks (not sold yet) should be included in the first column and marked to today's date, and it'll all be kosher.

Ok, thx! Getting more interesting.. It's for sure going to take me a lot more than 5mins!

[shanrui_91]

is there any good guide to XIRR? I am still a bit confused. How do you account for the idle cash in the portfolio?

If you inject $5000 into your stock portfolio, but you only use $3000 to buy stock. 1 year later, the stock is worth $1500 and I have $2000 in cash.

+5000
-3000
+1500
2000 ??

[smallcaps]

I think it should be like this and XIRR = -0.3 in this case

-5000 1/1/2011
1500 1/1/2012
2000 1/1/2012

[swakoo]

If you inject $5000 into your stock portfolio, but you only use $3000 to buy stock. 1 year later, the stock is worth $1500 and I have $2000 in cash.

smallcaps is right.

An alternative way to view this is:

1 Jan 2011: 3000 (cash injection used to buy stocks)
1 Jan 2011: 2000 (remainder of cash injection, unused)
1 Jan 2012: -1500 (market value of stocks, that could have been taken out hence negative)
1 Jan 2012: -2000 (remainder of cash injection, still unused, that could have been taken out hence negative)

XIRR = -30%

Notes:
1) Need to use the same sign for inflow or outflow. Doesn't matter if it's - or + for one or the other so long as it's used consistently.
2) Assets remaining need to be expressed at current market value and treated as outflow, even if not cashed out yet.

[CityFarmer]

To keep it simple, the way i did are

- I put all transactions in a list, outflow (-ve for dividend, sale etc), inflow (+ve for injection of $)
- current market value will include spare investment fund if applicable. The current market value will be the last item of the year with -ve as outflow
- to begin a new year, i put starting market value as inflow (+ve). It should be similar as the previous year market value.

So i will have XIRR for each year

[shanrui_91]

so under the XIRR system, if you made a profit of 1% in 1 day, it will give you 365% return and loss of 1% in 1 day will give you -100% return. In actual fact that could be your only trade done for the year and your NAV only changes by 1%

[nsengkia]

I agree that when calculating IRR, all complete dividend and transactions with all commissions and brokerage fees must be included. However, I think what is missing is the accounting for idle cash as one is looking at a portfolio return rather than a return from stock purchased.

The more accurate approach maybe to have a portfolio (comprising of both stocks and shares and standby cash) set aside and to track additions and withdrawals to that portfolio.

I will use my SRS Account as an example as I have full records to do the analysis. I started my investment journey on 31 Oct 04 with $10,812 in cash carried over from my SRS contribution of the previous year. I subsequently contributed additional funds into my SRS Account on the following dates:

Dates Contribution
31-Oct-04 (Start) $10,812
13-Nov-04 $14,025
31-May-05 $12,750
10-Mar-06 $11,475
17-Jan-07 $11,475
11-Jan-08 $11,475
25-May-09 $11,475
22-Jan-10 $11,475
19-Jan-11 $11,475
18-Apr-11 $1,275
11-May-12 $12,750

My SRS account has grown over the years:

Dates SRS Account STI
(incl Div) (excl Div)
31-Dec-04 $24,377 2066.14
31-Dec-05 $41,469 2347.34
31-Dec-06 $70,089 2985.83
31-Dec-07 $94,935 3482.30
31-Dec-08 $63,476 1761.56
31-Dec-09 $131,256 2897.62
31-Dec-10 $177,368 3190.04
31-Dec-11 $162,758 2646.35
31-May-12 $200,999 2772.54

The first advantage of this approach is that the growth of my SRS account can be compared against the growth of the overall Singapore Stock Market as measured by the Straits Times Index (STI) as given in the table above.

Taking into account my yearly contributions, I have worked out the Internal Rate of Return (IRR) of my SRS account and benchmarked it against the STI for comparison. Do note that the comparison IS biased in favor of my SRS account as it includes dividends whereas the STI does not.

Period of IRR SRS Account STI
(incl Div) (excl Div)
IRR from 31 Oct 04 to 31 Dec 04 -12% 29%
IRR 2005 14% 14%
IRR 2006 34% 27%
IRR 2007 17% 17%
IRR 2008 -40% -49%
IRR 2009 81% 64%
IRR 2010 24% 10%
IRR 2011 -14% -17%
IRR from 31 Dec 11 to 31 May 12 41% 12%
IRR from 31 Oct 04 to 31 Dec 12 9% 4%
IRR from 31 Oct 04 to 31 May 12 11% 5%
IRR from 31 Dec 06 to 31 Dec 12 6% -2%
IRR from 31 Dec 06 to 31 May 12 9% -1%

With an out-performance of about 6% per year my SRS should be outperforming the STI as the latter’s current dividend yield is about 2.92%.

The second advantage of this approach is that I can track my out-performance over time to gauge if I am improving or if I should just give up and go with the traditional passive ETF investment model. From the data, it appears that all of my out-performance occurred only from 2006 onwards (out-performance of 10% per year) so I think I am getting the hang of journeying on this road less traveled.

Finally to answer the topic of this thread, I believe that for me an overall absolute realistic return on value investing is of the order of 9 - 11% with a bias towards the upper end. The best case scenario based of the data I have presented above comprises (hopefully) of an STI growth of 5% per year and a portfolio out-performance (over and above the inclusion of dividends) of 10% per year.

BTW, two minor conceptual errors to correct on postings on MusicWhiz’s performance. STI 5-year return (excluding dividends though) should be based on

31 Dec 2006 – 2985.83 to 31 Dec 2011 - 2,646.35

rather than

1 Jan 2007 - 2,918.63 to 31 Dec 2011 - 2,646.35

and reinvested dividends only affect the invested amount and the final size of his investment portfolio and not his overall CAGR performance.

[CityFarmer]

so under the XIRR system, if you made a profit of 1% in 1 day, it will give you 365% return and loss of 1% in 1 day will give you -100% return. In actual fact that could be your only trade done for the year and your NAV only changes by 1%

If you calculate XIRR at the end of THE day, yes you are right.

If you calculate XIRR at the end of the year, i believe the return is still 1%, consistent with NAV method.

[Some-one]

Would the returns using XIRR be very far off from assuming that the amount is deposited from the start of the year? For example, assuming that I buy another stock on 15 May 2011. By right, I should be using XIRR to calculate the returns for 2011 to be accurate, but let's say I am lazy and decide to assume that the amount that I use to buy the stock is done on 1 January 2011 instead. As such, I would be using "(end of year amount-start of year amount/start of year)*100%". Would the XIRR return veered far off from my previous formula?

Another question. If I decide to use my portfolio that I started 5 years ago as starting point and the portfolio that I uses 5 years later as the ending point, the XIRR would be considered as annualised (as in yearly) return for 5 years or returns from 5 years of investment?