By Brent Pritchard

Growing up, I remember my Grandpa Schlieman and uncles bird hunting on the farm around the holidays. I never remember them deer hunting. I’m pretty sure venison sausage would have been one of my earliest memories.

I remember my first finance class like it was yesterday—both as a student and educator. Your first finance class is fertile ground for one-liners. You know the kind I’m talking about: risk requires return.

Here’s an excerpt from my book Would Your Boomerang Return? What Birds, Hurdlers, and Boomerangs Can Teach Us About the Time Value of Money (2023):

If compound investment yield is an investor’s best friend, time is a close second. In the Time Value of Money nomenclature, the expected return on investment or true investment yield is denoted with an “i.” It’s the exponent “N” that makes return on return on investment or compound investment yield possible. It’s because of the power of “N” that Albert Einstein reportedly thought that “Compound interest is the most powerful force in the universe.” Implicit in this statement is that he thought it was even more powerful than gravity, which ironically helped the smaller snowball roll down the mountain in the comic strip illustration!

The true investment yield or expected return on investment as denoted by “i” is not to be confused with Return on Investment (ROI). ROI doesn’t consider that money has time value. To illustrate this point, let’s reconnect with our “investor” from the last chapter who had a bird in the hand and was staring at two in the bush.

The ROI on a successful “bird investment” would have been 100%: two birds for one. But there was no mention of time. Was this investor hunter thinking that delaying consumption—this takes on a new meaning—of the bird in the hand was worth two in the bush…in twelve months? In other words, should 100% have been thought of as a true annual investment yield? Time is an important consideration when it comes to determining the true investment yield. See how ROI ignores time. ROI has application in practice, and there’s a time and a place for using this and other metrics to measure and evaluate potential investments. But it’s not in the context of the Time Value of Money.

Since ROI doesn’t consider that money has time value, it’s incompatible with the Mathematics of Finance. ROI is a simple measure of return. When we dive deep into the discussion regarding the true investment yield, you’ll discover that the word simple or nominal is used to describe an investment yield that doesn’t consider the effects of compounding.

So if the investment metric ROI isn’t “i,” then what is? That would be the Internal Rate of Return (IRR or as I like to write it, i(RR)). The i(RR) is the discount rate that sets the Present Value of the future expected cash flows over the investment period equal to the investment. Unlike ROI, i(RR) is Time Value of Money approved! The time span of the i(RR) must correspond with the time span in between the periods or payments (on the timeline). For example, if the time span in between period markers on the timeline represents annual periods, then the i(RR) is a true annual investment yield. A product of the finance industry, of course i(RR) is going to consider time.

And if that’s not enough, here’s the starter:

What is your earliest memory from a finance class(room)?

Brent Pritchard is an author and college finance educator with over two decades of industry experience and cofounder of Boxholm Press, LLC, a family-owned-and-operated publishing company providing educational content, products, and services. He pioneers an innovative and approachable new way of learning and teaching the Time Value of Money as well as thought leadership in other business topics. His most recent book is Would Your Boomerang Return? You can contact him on his website here.