CAGR, IRR, and TWRR: Investment Returns Explained

You check your portfolio. You invested a total of $50,000. It is now worth $85,000. What was your return?

The answer depends on who is asking and how you calculate it. The same portfolio can show a 7% return, a 10% return, or a 12% return depending on which formula you use. None of them are wrong. They just measure different things.

This matters because picking the wrong metric leads to bad decisions. You might think you are beating the market when you are not. You might think your fund manager is underperforming when the problem is actually your own contribution timing. Understanding the difference takes five minutes and saves you from years of confusion.

Contents

• Simple return: the starting point
• CAGR: the smoothed annual return
• AAR: the misleading average
• IRR: what your money actually earned
• TWRR: how the fund performed
• Which one should you use?
• A real example
• Frequently asked questions

Simple return: the starting point

Total return is the most basic measure. You put in $50,000, you now have $85,000, your total return is 70%. It tells you how much you made in total but says nothing about how long it took or when the money went in.

The formula: (ending value - total invested) / total invested * 100

Total return is useful for a quick gut check but useless for comparing investments over different time periods. A 70% return over 5 years is excellent. Over 30 years, it is terrible. You need an annualised number.

CAGR: the smoothed annual return

CAGR (Compound Annual Growth Rate) takes a starting value, an ending value, and the number of years, then tells you the constant annual rate that would get you from A to B.

The formula: (ending value / starting value) ^ (1 / years) - 1

If you invested $10,000 and it grew to $21,589 over 10 years, your CAGR is 8%. The actual yearly returns were probably all over the place - up 25% one year, down 15% the next - but the CAGR smooths it into a single number.

CAGR is the standard way to quote long-term market performance. When people say "the S&P 500 returns about 10% per year", they mean the CAGR. You can verify this yourself with our compound interest calculator.

When CAGR works: comparing the performance of two lump-sum investments over the same period. "I put $10,000 into Fund A and $10,000 into Fund B ten years ago. Which did better?" CAGR answers this perfectly.

When CAGR breaks down: the moment you add or withdraw money. If you invested $10,000 on day one and then added another $50,000 halfway through, CAGR has no idea what to do with that. It only sees a start value and an end value.

AAR: the misleading average

AAR (Average Annual Return) is the simple arithmetic mean of each year's return. Add up all the yearly returns and divide by the number of years.

If a fund returned +20%, -10%, and +15% over three years, the AAR is (20 - 10 + 15) / 3 = 8.3%.

The problem is that AAR overstates your actual return. Here is why. If you start with $100, gain 50% (now $150), then lose 50% (now $75), your AAR is 0%. But you lost $25. The average says you broke even when you clearly did not.

CAGR would correctly show -13.4% per year. AAR shows 0%. This is why financial journalists sometimes quote AAR to make returns look better than they are.

When AAR is useful: almost never for individual investors. Fund fact sheets sometimes report it, which is why you need to know what it is - so you can ignore it in favour of CAGR or IRR.

IRR: what your money actually earned

IRR (Internal Rate of Return) is the annualised return that accounts for the timing and size of every contribution and withdrawal. It answers the question: "given when I actually put money in and took it out, what annual rate did my money earn?"

This is the metric that matters most if you invest regularly - which most people do. If you put $200 into an index fund every month, CAGR cannot tell you your return because there is no single "start value". IRR can.

Think of it this way: your first $200 has been compounding for years. Your most recent $200 has been in for a month. IRR finds the single annual rate that explains your final portfolio value given all those different entry points.

Our time in the market calculator uses IRR to show the true annualised return of each strategy, which is why the Consistent Investor shows returns close to the S&P 500's historical ~10% CAGR rather than the misleadingly low numbers you get from dividing final value by total invested.

When IRR works: measuring your personal investment performance when you have made multiple contributions over time. This is the number that tells you how well your money actually did.

When IRR breaks down: comparing your performance to a benchmark. IRR is affected by how much you invested and when. If you happened to invest a large sum right before a bull run, your IRR will look great even if the fund itself was average. For that, you need TWRR.

TWRR: how the fund performed

TWRR (Time-Weighted Rate of Return) strips out the effect of cash flows entirely. It measures the return of the investment itself, as if no money was ever added or withdrawn.

TWRR works by breaking the period into sub-periods between each cash flow, calculating the return for each sub-period, and then geometrically linking them together. The result is a return that reflects only the fund's performance, not your timing.

This is what fund managers report. It is the industry standard for performance reporting because it isolates the manager's investment decisions from the investor's contribution decisions. A fund manager should not be penalised because a large client happened to invest the day before a crash.

When TWRR works: comparing a fund manager's performance against a benchmark. "Did this fund beat the S&P 500?" TWRR answers this fairly.

When TWRR is misleading for you: it does not reflect your actual experience. A fund with a 12% TWRR might have earned you only 6% IRR if you invested most of your money right before a downturn. The fund did well. Your timing did not.

Which one should you use?

For most people reading this site - regular investors putting money into index funds monthly through an ISA or SIPP - IRR is the number that matters. It tells you what your money actually earned given your real contribution pattern.

CAGR is useful for understanding market history and comparing lump-sum scenarios. TWRR is useful if you are evaluating a fund manager.

AAR is useful for misleading people in fund marketing materials.

A real example

Say you invested $200 per month into the S&P 500 from 2000 to 2025. Your total contributions are $60,000. Your portfolio is now worth roughly $230,000.

• Total return: 283% (you nearly quadrupled your money)
• CAGR: not directly applicable because you did not invest a lump sum
• Naive annualised: (230,000 / 60,000) ^ (1/25) - 1 = 5.5% (misleadingly low)
• IRR: approximately 9.2% (your money earned close to the S&P 500's long-term average)

The naive annualised figure of 5.5% makes it look like the market underperformed. The IRR of 9.2% tells the true story: the S&P 500 did roughly what it always does, and your money benefited from it. The difference is entirely down to the fact that your later contributions had less time to compound.

This is exactly the mistake our time in the market calculator was built to correct. The early version showed misleadingly low annualised returns because it used the naive formula. Once we switched to IRR, the numbers matched reality.

Frequently asked questions

What does CAGR stand for?

Compound Annual Growth Rate. It is the constant annual return that turns a starting value into an ending value over a given number of years. It assumes a single lump sum invested at the start with no additions or withdrawals.

Is IRR the same as XIRR?

XIRR is the Excel function that calculates IRR using specific dates for each cash flow. Standard IRR assumes equal time periods between flows. For monthly investing they give very similar results. XIRR is more precise if your contributions are irregular.

Why do fund fact sheets not show IRR?

Because IRR depends on when you personally invested. Your IRR for the same fund is different from someone else's IRR if you started at different times or invested different amounts. Fund managers report TWRR because it is the same for everyone and isolates the fund's performance from individual timing.

Can IRR be negative?

Yes. If your portfolio is worth less than what you put in, your IRR is negative. This means your money lost value on an annualised basis after accounting for the timing of contributions.

Which return does HMRC use for tax?

HMRC does not care about annualised returns. Capital Gains Tax is based on your total gain: proceeds minus cost basis. The timing of contributions affects your cost basis but the tax calculation is a simple profit figure, not a rate of return.

Read Next

• Time in the Market Beats Timing the Market
• Drip Feed vs Lump Sum Investing: Which Strategy Wins?
• A Beginner's Guide to Investing in the UK

The Psychology of Money - Morgan Housel - Housel's chapter on compounding is the most accessible explanation of why returns feel unintuitive over long periods. Essential reading. (Affiliate link - we may earn a small commission at no extra cost to you.)