At the surface, measuring return is easy. You make a profit if you get back more than what you put in. If I put in $1,000 and get $1,200 back, then I make $200 of profit or 20% return. But there is a big difference between making that return in one month versus in one year.

Internal rate of return ("IRR") is a metric that annualizes the return. So if you put in $1,000 on January 1, 2022 and get back $1,200 on February 1, 2022, then the IRR using actual calendar dates (slightly different form taking 1.2^12-1) is 756%. What it means is that if you can keep redeploying the capital at the same rate of return throughout the year, then you should make 756% when the year is over.

The advantage of IRR is that it can accept multiple cash flows to create one rate of return. For example, you may have 10 outcomes incepting and exiting on different dates. You can calculate a single IRR to measure how well you are doing in aggregate. The disadvantage, however, is that IRR is generally not meaningful when you are losing money.

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