ROI vs IRR: Which Investment Metric Should You Use?

ROI and IRR are two of the most common investment performance metrics, but they serve different purposes and can give drastically different results for the same investment. Understanding when to use each one is crucial for making informed financial decisions.

The Quick Answer

What is ROI?

ROI (Return on Investment) measures the simple profit or loss relative to your initial investment. It's expressed as a percentage.

ROI Formula

ROI = (Final Value - Initial Investment) / Initial Investment × 100%

Example: Stock Investment

• You buy stock for $10,000
• You sell it for $15,000
• ROI = ($15,000 - $10,000) / $10,000 = 50%

Simple, right? That's the beauty of ROI. Calculate your ROI instantly →

What is IRR?

IRR (Internal Rate of Return) measures the annualized rate of return, accounting for the timing of all cash flows. It's the discount rate that makes the Net Present Value (NPV) of an investment equal to zero.

IRR Formula

0 = CF₀ + CF₁/(1+IRR)¹ + CF₂/(1+IRR)² + ... + CFₙ/(1+IRR)ⁿ

Where CF₀ is the initial investment (negative) and subsequent CFs are cash inflows. Learn how to calculate IRR step-by-step →

Example: Multi-Year Investment

• Year 0: Invest $10,000
• Year 1: Receive $3,000
• Year 2: Receive $4,000
• Year 3: Receive $5,000
• IRR ≈ 12.4% annually

More complex, but captures the time value of money. Calculate your IRR instantly →

Key Differences at a Glance

Feature	ROI	IRR
Complexity	Simple	Complex
Time Consideration	Ignores timing	Accounts for timing
Result Type	Total % return	Annualized % return
Cash Flows	Initial + Final only	All intermediate flows
Best For	Quick comparisons	Detailed analysis

The Critical Difference: Time Matters

Here's where ROI and IRR can tell completely different stories about the same investment.

Example: Two Investment Options

Investment A:

• Invest $100,000 today
• Receive $150,000 in 1 year
• ROI: 50%
• IRR: 50% annually

Investment B:

• Invest $100,000 today
• Receive $150,000 in 5 years
• ROI: 50% (same!)
• IRR: 8.4% annually (much lower!)

The Insight: Both investments have the same ROI (50%), but Investment A is clearly better because you get your money back faster. IRR captures this by showing an annualized return—Investment A's 50% annual return vs Investment B's 8.4% annual return.

When to Use ROI

ROI is Best For:

• Simple investments - Buy at X, sell at Y
• Short timeframes - Less than 1 year
• Quick comparisons - When you need a rough sense of profitability
• Marketing/Business decisions - "This ad campaign gave us 300% ROI"
• Same time periods - Comparing two 6-month investments

ROI Examples in Real Life:

• Flipping houses (buy, renovate, sell quickly)
• Short-term stock trades
• Business expense ROI (equipment, training)
• Marketing campaign effectiveness

Calculate ROI for your investment →

When to Use IRR

IRR is Best For:

• Multi-period investments - Cash flows over multiple years
• Different timeframes - Comparing a 3-year vs 7-year investment
• Intermediate cash flows - Dividends, rental income, partial exits
• Real estate - Ongoing rental income plus eventual sale
• Private equity/VC - Multiple funding rounds and exits

IRR Examples in Real Life:

• Real estate investments with rental income
• Private equity fund performance
• Corporate capital projects
• Long-term stock portfolios with dividends
• Bond investments with coupon payments

Calculate IRR for your investment →

Side-by-Side Comparison: Real Estate Example

Scenario: Rental Property Investment

• Year 0: Purchase for $300,000
• Years 1-5: Earn $24,000/year in net rental income
• Year 5: Sell for $450,000

ROI Calculation

Total Cash In: ($24,000 × 5) + $450,000 = $570,000
Total Cash Out: $300,000
ROI = ($570,000 - $300,000) / $300,000 = 90%

IRR Calculation

Using the cash flows:

• Year 0: -$300,000
• Year 1: +$24,000
• Year 2: +$24,000
• Year 3: +$24,000
• Year 4: +$24,000
• Year 5: +$474,000

IRR = 15.3% annually

Interpretation

• ROI tells you: You made a total return of 90% over 5 years
• IRR tells you: Your annualized return was 15.3%

Both are correct! IRR is more useful for comparing this to other 5-year investments or to your required rate of return.

Common Mistakes

Mistake #1: Using ROI for Different Time Periods

Wrong: "Investment A has 50% ROI in 6 months, Investment B has 60% ROI in 3 years. Let's pick B!"

Right: Use IRR to annualize both returns for fair comparison.

Mistake #2: Ignoring Intermediate Cash Flows

Wrong: Only looking at initial cost and final sale price for rental property

Right: Use IRR to account for all the rental income received along the way

Mistake #3: Comparing IRR Across Different Sizes

Wrong: "Investment A has 30% IRR on $10,000. Investment B has 25% IRR on $1,000,000. A is better!"

Right: Consider absolute dollar returns too. A 25% IRR on $1M is $250,000/year, much better than 30% IRR on $10,000 ($3,000/year).

Mistake #4: Ignoring Risk

Neither ROI nor IRR account for risk. Always consider:

• Investment risk level
• Liquidity (can you exit early?)
• Market conditions
• Your personal risk tolerance

ROI vs IRR: Decision Framework

Advanced: Modified Internal Rate of Return (MIRR)

MIRR addresses some of IRR's limitations by assuming:

• Positive cash flows are reinvested at your cost of capital (more realistic)
• Negative cash flows are financed at your financing rate

MIRR often gives a more conservative, realistic return estimate than standard IRR.

What About XIRR?

When your cash flows don't occur at regular intervals (monthly investments, irregular dividends, etc.), use XIRR instead of standard IRR. XIRR accounts for the exact dates of each transaction, giving you more accurate returns for real-world portfolios. Learn about XIRR →

Using Both Together

The best approach? Use both!

• ROI gives you the big picture: total return percentage
• IRR tells you if that return was achieved fast enough

For the rental property example:

• 90% ROI sounds great
• 15.3% IRR confirms it's a solid investment (above most benchmarks)

Industry Benchmarks

ROI Benchmarks

• Marketing campaigns: 400-500% ROI is excellent
• Business equipment: 50-100% ROI over useful life
• Stock trading: 10-20% annual ROI is good

IRR Benchmarks

• Real estate: 12-20% IRR
• Private equity: 20-30% IRR
• Venture capital: 25-35%+ IRR
• Corporate projects: Must exceed WACC (7-12% typically)

Frequently Asked Questions

Can IRR and ROI be the same?

Yes, when the investment period is exactly 1 year with no intermediate cash flows, IRR and ROI will be identical.

Which is more accurate?

Neither is "more accurate"—they measure different things. IRR is more comprehensive because it accounts for timing.

Do professional investors use ROI or IRR?

Professional investors primarily use IRR (and NPV) because they handle complex, multi-period investments. ROI is more common in business operations and marketing. Learn more: IRR vs. NPV comparison.

Can IRR be negative while ROI is positive?

No. If your total return is positive (positive ROI), your annualized return (IRR) must also be positive.

What if I can't calculate IRR?

Use our free calculator! IRR requires iterative solving (Newton-Raphson method) that's impractical by hand.

Conclusion

ROI and IRR aren't competing metrics—they're complementary tools that serve different purposes:

• ROI is your go-to for simple, quick profitability checks
• IRR is essential for sophisticated, time-sensitive investment analysis

Master both, and you'll make better investment decisions across all asset classes.