You may have been using XIRR to measure portfolio performance and may have faced these two common issues:
- Cash withdrawal from your portfolio for spending (exchange your investment dollars to enjoy life)
- Cash injection into your portfolio as new capital for investing
Cash Withdrawal will improve XIRR
See the following examples for Investor A . His XIRR and his investment portfolio.
His XIRR as on 31 Dec 2011 since investment = 14.3%
Assuming he has decided to withdraw $10K cash from his investment portfolio for his overseas holidays trip.
So after withdrawing $10K from his investment portfolio, his XIRR will look like this:
His XIRR immediately improves from 14.3% to 14.5%. The more money he spent from his investment portfolio and more his XIRR improves. This is really NONSENSE!!!
For cash withdrawal from investment portfolio, we will have to make pro rated adjustment to both Capital and Realized Gains.
Here is the Maths:
Firstly, you have to express Capital and Realized Gains in the investment portfolio as ratio:
- Capital as ratio of Total Capital and Realized Gain
- Realized Gains as ration of Total Capital and Realized Gain
See an example of withdraw $10K from the investment portfolio for Investor A.
After his cash withdrawal of $10K from his investment account; his XIRR dropped slightly from 14.3% to 13.6% , partly due to the effect of Unrealized losses in his portfolio.
Cash injection into your portfolio as new capital for investing
When you have spare cash from your earned income that you want to invest. There is no need to immediately inject it into your investment portfolio as NEW capital and account it in XIRR formula if you haven't use this cash to purchase any stocks yet. This will help to make your XIRR looked much better. Similarly, don't deceive yourself by removing some old capital in your investment portfolio and improves XIRR too. LOL