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Online Investing Hacks by Bonnie Biafore

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Hack #84. Compare Returns for Alternative Investments

Converting different types of investment into the same form of compound-interest problem makes comparisons easy.

Financial calculations all revolve around the same set of parameters: present value, future value, interest or return rate, number of periods, and payment. With any four of these parameters, you can solve for the fifth, which means that with a few qualifications you can turn any type of investment into an apple and then compare all the apples to see which one is the best for your situation. To make the most meaningful comparisons with investments, the number of periods and the payment must be the same for each alternative.

Whether you calculate financial measures by hand or use a spreadsheet, the parameters are the same. If you use Excel for finance, the IRR (internal rate of return), XIRR (internal rate of return for irregular cash flows), PV (present value), FV (future value),and PMT (payment) functions all use or solve for the following parameters in one form or another:

Rate

The interest or investment rate per period. For example, if you are evaluating the annual growth for a stock, the rate is the growth for one year.

Nper

The total number of payment periods in an annuity. If you are evaluating the annual growth of a stock that you held for five years, Nper is 5.

PV

The cash value at the beginning of the evaluation period.

Pmt

The payment made each period, which must remain the same for each period. IRR and XIRR use ...

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