The Human Side of Internal Rate Of Return
By: Patrick Corrigan
In the world of finance, a classic measurement of an investment’s success is its Internal Rate of Return (IRR). This metric is mostly used when it comes to valuing the return of a project (like a real estate investment) that was purchased for a certain price, held for a period, and then sold. The higher the IRR, the better the investment performed. Having worked with this metric for several years I have always loved the term IRR but have always thought it should also apply to the bigger picture idea of how we think and feel about our financial life being in balance and helping one achieve what is important to them.
Borrowing the pyramid from American psychologist Abraham Maslow’s heirarchy of needs, the higher a person progresses to the top of the pyramid, the higher their IRR would be.
It seems, more often than not, the role of financial planning is set around achieving a person’s basic needs and rarely do planners venture up the pyramid with all of their clients to help them maximize their life (I’m guilty of this too). Frankly, it is easier on the planner and the client to simply solve for a rate of return (or IRR) they might need from their investments to ensure they are not a financial burden to others. This way they can meet a few of the physiological needs that Maslow mentions, but is this really the IRR we should be working towards?
I recently had a conversation with a client who shared her philosophy on what money means to her and how she values it’s purpose. She said being financially secure allows her to operate from a place that is truly her own; to be able to think and act freely without feeling the pressure or need to conform to others’ ideas or impressions of what is best for her. She is freed from following the herd and can be guided by her true intentions in life.
Her definition of money might not perfectly match yours, but I think it is safe to say that her IRR is leading her to the top of her pyramid.
So, does the person with the most money inherently have the best chance at reaching their highest IRR? Or, said in a more conventional way, can money buy happiness? Maybe, but when this comes up for me, I reflect on this quote by American philosopher, poet, and essayist Ralph Waldo Emerson:
“The purpose of life is not to be happy. It is to be useful, to be honorable, to be compassionate, to have it make some difference that you lived and lived well.”
Of course, it’s a natural human instinct to want to experience happiness. And if happiness is indeed to be attained, can you think of a more compelling formula than Mr. Emerson’s? Neither can I.