We often get asked “what is the performance or return of my Raiz investment”.
Calculating how an investment is performing is typically done using one of two standard methods that you may have heard of before. One method is called Return on Investment (ROI) and the other is called the Internal Rate of Return (IRR).
Return on Investment (ROI)
First, let’s look at ROI, which is the most basic way to measure the performance of an investment.
Now typically ROI is used for simple investments where you make a single investment on a particular date and hold that investment for a period.
To calculate ROI you would divide the change in the value of your investment for the period by the original cost of your investment, and the result is a percentage. The higher the percentage, the harder your investment is working for you.
So, if you invested $100 and then 1 year later your investment was worth $110, we would calculate ROI as:
$$ {$110-$100 \over $100}\times 100=10\%$$
The limitation of ROI is that it cannot account for many small investments made at different times. Each individual investment would have its own unique ROI and there is no easy way to combine them into a single percentage as even trying to take an ‘average’ would result in something quite meaningless.
When you consider your Raiz account, because of normal market fluctuations, if you were to make a $10 investment when you first opened your account, it would make a different return than an investment of $10 made a year later.
Let’s assume you have had your account open for two years. If the market fell 10% in the first year, and then went back up by 20% in the second year, the investments made midway through the period would have a greater return than the ones made at the start.
So attempting to use ROI in micro-investing situations such as your Raiz account simply does not work, as the investment is too complex, and we have not even begun to consider any withdrawals that you may have made during the period.
So what about calculating performance using IRR?
Well, IRR can be used to calculate the estimated annual return of an investment that has many different deposits and withdrawals made over time. It is the return that makes all your cashflows, in and out, equal to your current balance.
Using our example above, where the market goes down 10% in the first year and then back up 20% in the second year, if we had made a $100 deposit in each of the two years, our account balance would grow to be $228.
On a simple return this is roughly 6.8% p.a. However, the IRR to make the two $100 investments made at different times, equal to $228 after 2 years, is 9% p.a. This gives us a more representative return that considers multiple deposits over differing market conditions. If you’d like to see the maths, it is calculated as:
$$ $100 \times 1.09^2 + $100 \times 1.09 = $228 $$
The downside of IRR
IRR is time consuming to calculate as it must be done through trial-and-error. It also needs to take into account every deposit and withdrawal made on an investment account since it was first opened.
As you can imagine, we would need to do this for hundreds of thousands of customer accounts, and this would take an enormous amount of computational power to calculate.
Even if it only took 100 milliseconds for a computer to retrieve the data and calculate the IRR of one customer account, when we multiply that by 225,000 customer accounts, it would take 22,500 seconds.
That’s a mind blowing 6 hours and 15 minutes of processing time to compute the IRR for the entire Raiz customer base. This means at the moment it is simply not practical for Raiz to use IRR in real-time while maintaining a good user experience.
Our Solution
Our solution to this problem is that we use a modified calculation.
Our modified calculation gives an approximation of the figure which could be achieved by doing the standard IRR. We do this by using your average balance over the period to calculate your returns.
When the average balance is calculated, it takes into account all deposits and withdrawals, and by using this modified method, the calculation becomes simpler and quicker to run than an IRR calculation.
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Important Information
The information on this website is general advice only. This means it does not take into account any person’s particular investment objectives, financial situation or investment needs. If you are an investor, you should consult your licensed adviser before acting on any information contained in this article to fully understand the benefits and risk associated with the product.
A Product Disclosure Statement for Raiz Invest and/or Raiz Invest Super are available on the Raiz Invest website and App. A person must read and consider the Product Disclosure Statement in deciding whether, or not, to acquire and continue to hold interests in the product. The risks of investing in this product are fully set out in the Product Disclosure Statement and include the risks that would ordinarily apply to investing.
The information may be based on assumptions or market conditions which change without notice. This could impact the accuracy of the information.
Under no circumstances is the information to be used by, or presented to, a person for the purposes of deciding about investing in Raiz Invest or Raiz Invest Super.
Past return performance of the Raiz products should not be relied on for making a decision to invest in a Raiz product and is not a good predictor of future performance.
