IRR vs. Interest Rates
Yes, if your IRR is 5% per annum after three years then the total return (I prefer total rather than your use of actual) over those three years is 15.76%. Note that if you have other cashflows in and out, it gets a bit more complicated (e.g. using the XIRR function in Excel), but the idea is to find an effective annual percentage return that you're getting for your money. IRR is not subjective, this is a response to @Laythesmack, to his remark that IRR is subjective. Not that I feel a need to defend my position, but rather, I'm going to explain his.  My company offered stock at a 15% discount. We would have money withheld from pay, and twice per year buy at that discount. Coworkers said it was a 15% gain. I offered some math. I started by saying that 100/85 was 17.6%, and that was in fact, the gain. But, the funds were held by the company for an average of 3 months, not 6, so that gain occurred in 3 months and I did the math 1.176^4 and resulted in 91.5% annual return. This is IRR.  It's not that it's subjective, but it assumes the funds continue to be invested fully during the time. In our case the 91.5% was real in one sense, yet no one doubled their money in just over a year.  Was the 91% useless? Not quite. It simply meant to me that coworkers who didn't participate were overlooking the fact that if they borrowed money at a reasonable rate, they'd exceed that rate, especially for the fact that credit lines are charged day to day. Even if they borrowed that money on a credit card, they'd come out ahead.  IRR is a metric. It has no emotion, no personality, no goals. It's a number we can calculate. It's up to you to use it correctly. Yes, assuming that your cash flow is constantly of size 5 and initial investment is 100, the following applies: IRR of 5% over 3 years: Value of CashFlows: 4.7619 + 4.5351 + 4.3192 = 13.6162 NPV: 100 - 13.6162 = 86.3838 Continuous compounding: 86.3838 * (1.05^3) = 100 IRR is subjective, if you could provide another metric instead of the IRR; then this would make sense. You can't spend IRR. For example, you purchase a property with a down payment; and the property provides cash-flow; you could show that your internal rate of return is 35%, but your actual rate of importance could be the RoR, or Cap Rate. I feel that IRR is very subjective. IRR is hardly looked at top MBA programs. It's studied, but other metrics are used, such as ROI, ROR, etc. IRR should be a tool that you visually compare to another metric. IRR can be very misleading, for example it's like the cash on cash return on an investment.
According to my wife who used to work in the industry, since an investment mortgage is more likely to fail (they are just riskier) there are higher loan to value requirements and higher interest rates. They are just different products for different situations. Interest rates are always given annually, to make them comparable. If you prefer to calculate the rate or the total interest for the complete time, like 10 years or 15 years or 30 years, it is simple math, and it tells you the total you will pay, but it is not helpful for picking the better or even the right offer for your situation. Compare it to your car's gas mileage- what sense does it make to provide the information that a car will use 5000 gallons of gas over its lifetime? Is that better than a car that uses 6000 gallons (but may live 2 years longer?) "I did a rough model and in terms of total $$ paid (interest + penalty - alternative investment income) both options are almost the same with the ""paying it all upfront"" being perhaps a $300 or so better ($9200 vs $8900) However, that doesn't factor in inflation or tax considerations. Personally I'd go with the ""no-penalty"" scenario since you have more flexibility and can adjust along the way if anything else comes up in the meantime." Generically, interest rates being charged are driven in large part by the central bank's rate and competition tends to keep similar loans priced fairly close to each other. Interest rates being paid are driven by what's needed to get folks to lend you their money (deposit in bank, purchase bonds) so it's again related. There certainly isn't very direct coupling, but in general interest rates of all sorts do tend to swing (very) roughly in the same direction at (very) roughly the same time... so the concept that interest rates of all types are rising or falling at any given moment is a simplification but not wholly unreasonable. If you want to know which interest rates a particular person is citing to back up their claim you really need to ask them. Asset prices are inversely related to interest rates. If you're valuing a business or a bond, if you use a lower interest rate you get a higher valuation.  Historic equity returns benefit from a falling interest rate environment which won't be repeated as interest rates can only go so low.  edit: typo What is much more likely is immediate or close to immediate investment.  but this is exactly my point of contention with how they do things. I know for a fact that the money is immediately invested, which is why i find it wrong that interest for money collected in a given financial year is announced after the end of the next financial year.  i was wondering if this was a common practice in other countries. "I think this is a good question with no single right answer.  For a conservative investor, possible responses to low rates would be: Probably the best response is somewhere in the middle: consider riskier investments for a part of your portfolio, but still hold on to some cash, and in any case do not expect great results in a bad economy. For a more detailed analysis, let's consider the three main asset classes of cash, bonds, and stocks, and how they might preform in a low-interest-rate environment. (By ""stocks"" I really mean mutual funds that invest in a diversified mixture of stocks, rather than individual stocks, which would be even riskier.  You can use mutual funds for bonds too, although diversification is not important for government bonds.) Cash. Advantages: Safe in the short term.  Available on short notice for emergencies. Disadvantages: Low returns, and possibly inflation (although you retain the flexibility to move to other investments if inflation increases.) Bonds. Advantages: Somewhat higher returns than cash.  Disadvantages: Returns are still rather low, and more vulnerable to inflation.  Also the market price will drop temporarily if rates rise. Stocks. Advantages: Better at preserving your purchasing power against inflation in the long term (20 years or more, say.)  Returns are likely to be higher than stocks or bonds on average.  Disadvantages:  Price can fluctuate a lot in the short-to-medium term.  Also, expected returns are still less than they would be in better economic times. Although the low rates may change the question a little, the most important thing for an investor is still to be familiar with these basic asset classes.  Note that the best risk-adjusted reward might be attained by some mixture of the three." Both are correct depending on what you are really trying to evaluate. If you only want to understand how that particular investment you were taking money in and out of did by itself than you would ignore the cash.  You might use this if you were thinking of replacing that particular investment with another but keeping the in/out strategy. If you want to understand how the whole investment strategy worked (both the in/out motion and the choice of investment) than you would definitely want to include the cash component as that is necessary for the strategy and would be your final return if you implemented that strategy. As a side note, neither IRR or CAGR are not great ways to judge investment strategies as they have some odd timing issues and they don't take into account risk. The year over year compounding in India has the potential to make up for interest rate parity. But 3% isn't really going to create convenient amounts of earnings either until you get to larger amounts. I think sometimes this is simply ignorance. If my marginal tax rate is 25%, then I can either pay tax deductible interest of $10K or pay income tax of $2.5K.    I think most americans don't realize that paying $10K of tax deductible interest (think mortgage) only saves them $2.5K in taxes.  In other words, I'd be $7.5K ahead if I didn't have the debt, but did pay higher taxes. Q1: Which is better option and provide good returns between FD and RD ?  There is no right or wrong answer here and depends on rates, convenience, exactness of duration, etc and other things. In general an FD would give you better return than RD. Q2: Am I liable to pay income tax on the interest earned ? If you have a NRE/NRO account you are not liable for tax on interest in India. Note you may still be liable to pay tax on this in the US "they said the expected returns from the stock market are around 7-9%(ish).  (emphasis added) The key word in your quote is expected.  On average ""the market"" gains in the 7-9% range (more if you reinvest dividends), but there's a great deal of risk too, meaning that in any given year the market could be down 20% or be  up 30%. Your student loan, on the other hand, is risk free.  You are guaranteed to pay (lose) 4% a year in interest.  You can't directly compare the expected return of a risk-free asset with the expected return of a risky asset.  You can compare the risks of two assets with equal expected returns, and the expected returns of assets with equal risks, but you can't directly compare returns of assets with different risks.  So in two years, you might be better off if you had invested the money versus paying the loan, or you might be much worse off.  In ten years, your chances of coming out ahead are better, but still not guaranteed. What's confusing is I've heard that if you're investing, you should be investing in both stocks and bonds (since I'm young I wouldn't want to put much in bonds, though). So how would that factor in?  Bonds have lower risk (uncertainty) than stocks, but lower expected returns.  If you invest in both, your overall risk is lower, since sometimes (not always) the gain in stocks are offset by losses in bonds).  So there is value in diversifying, since you can get better expected returns from a diversified portfolio than from a single asset with a comparable amount of risk.  However, there it no risk-free asset that will have a better return than what you're paying in student loan interest." "The CBOE states, in an investor's guide to Interest Rate Options: The Options’ Underlying Values   Underlying values for the option contracts are   10 times the underlying Treasury yields (rates)—   13-week T-bill yield (for IRX), 5-year T-note   yield (for FVX), 10-year T-note yield (for TNX)   and 30-year T-bond yield (for TYX). The Yahoo! rate listed is the actual Treasury yield; the Google Finance and CBOE rates reflect the 10 times value.  I don't think there's a specific advantage to ""being contrary"", more likely it's a mistake, or just different." &gt; Does it make sense to calculate the IRR based on the outstanding value of the project, or just use the cash flows paid out?  What is the outstanding value of the project based on? I'm guessing it is the PV of net cash flow?  The timing of each cash outflow (i.e. investment) is crucial to calculating a proper IRR because of time value of money. Putting in $x each year for 49 years will give you a different figure from putting in $49x in the first year and zero for the next 48 years because a larger figure is tied up for a longer time period. "The definition you cite is correct, but obscure. I prefer a forward looking definition. Consider the real investment. You make an original investment at some point in time. You make a series of further deposits and withdrawals at specified times.  At some point after the last deposit/withdrawal, (the ""end"") the cash value of the investment is determined. Now, find a bank account that pays interest compounded daily. Possibly it should allow overdrafts where it charges the same interest rate. Make deposits and withdrawals to/from this account that match the investment payments in amount and date.  At the ""end"" the value in this bank account is the same as the investment. The bank interest rate that makes this happen is the IRR for the investment..."