The Number That Lies to You: Why IRR Is Fooling Your Whole Industry

Picture a pitch meeting. Not one you’re in, but one we’re watching, from a step back, the way you’d watch a scene you’ve seen play out a hundred times.

A sponsor is across the table from his investors. He’s not a con man. He’s good at his job, and the deal he’s presenting is real. He puts up one number and lets it sit there. Forty percent. A forty percent internal rate of return.

The room reacts the way rooms always react to that number. Eyebrows go up. Somebody nods. Forty percent is a spectacular number, and everyone in that room knows it — or believes they do. The sponsor isn’t lying to them. He earned that forty percent. If you were sitting there, you’d be impressed too.

And that’s exactly the problem. Because sitting in a drawer somewhere is a second deal — one he’s not leading with — that made his investors more money. And its IRR was half as big.

Let’s pull those two deals apart, because this is where the trouble lives.

Deal A is the star of the pitch. A quick flip. In and out in a year. Put in a dollar, get back a dollar-forty. Forty percent return in twelve months — a forty percent IRR. Dazzling.

Deal B is the one in the drawer. A patient hold. Seven years. Put in a dollar, get back three. You tripled the money. But spread across seven years, the IRR works out to around seventeen percent. Next to a forty, seventeen looks sleepy. Ordinary.

So look at what just happened. Deal A — the one with the gorgeous IRR — returned forty cents on the dollar. Deal B — the sleepy one, returned two hundred cents on the dollar. Deal B made five times as much money. And the number everyone trusts, the number that made the room lean in, recommended the worse deal.

How can a higher return be the worse outcome? That’s not a trick of the arithmetic. It’s telling you something about what IRR actually measures — and what it doesn’t.

Here’s the machine underneath it, and I’ll keep it simple, because the simplicity is the point.

IRR is a speed. It’s an annualized rate — how fast your money grew per year. And because it’s a speed, it rewards getting your capital back quickly, above almost everything else.

But it does something sneakier, and this is the part almost nobody says out loud. IRR quietly assumes that the instant a dollar comes back to you, you redeploy it — at that same dazzling rate — immediately, and forever. The forty percent deal assumes that when your money comes home in a year, you turn right around and put it into another forty percent deal.

But you can’t. That next deal may not exist. So your capital comes back fast and then sits there — in the bank, earning nothing — waiting. IRR never accounts for the waiting. It assumes a world of infinite forty percent deals lined up back to back, and that world has never existed for anyone.

The equity multiple doesn’t make that assumption. It just asks the honest question: how many dollars came back for every dollar you put in? One-point-four, or three. It doesn’t care how fast. It only cares how much. And in the end, how much is what you actually get to keep.

Now — the uncomfortable part.

Charlie Munger had a habit worth borrowing here: when a number confuses you, don’t ask whether it’s right. Ask what question it’s actually answering. Because IRR isn’t wrong. It’s answering a different question than the one you care about. You want to know how much money you made. IRR is telling you how fast. And in a world where you can’t instantly reinvest, fast and much drift apart — sometimes violently.

Which raises the real question of this episode. If everyone in the industry knows this — and they do; none of this is secret — why does the whole business still run on IRR?

And here’s the answer, said plainly, about us and not at you. Because IRR is the language of the fundraise. A big IRR raises the next fund. It fits on the pitch deck. It makes the sponsor look brilliant and the deal look urgent. We didn’t all agree to use a flawed number because we’re foolish. We use it because it flatters everyone at the table — the sponsor who’s selling and the investor who wants to believe. It’s a number that sells, and an entire profession has quietly organized itself around the number that sells rather than the number that’s true.

That’s not a story about villains. It’s a story about incentives. And incentives, as Munger would remind us, are stronger than intentions almost every time.

And here’s where it stops being a measurement problem and becomes a behavior problem.

Because a number you’re graded on doesn’t just describe your decisions. It starts making them. When IRR is the scorecard, and it rewards speed, watch what a rational sponsor is quietly pushed to do.

He sells the good building too early. He’s got a beautiful asset, compounding nicely, the kind of thing that would make his investors genuinely wealthy if he simply held it. But holding it drags his IRR down every year it sits. So he sells — clips a gaudy IRR, recycles the capital, and calls it discipline. He churns a great asset to feed a metric, and leaves the real money on the table.

That’s the deep cost. IRR doesn’t just occasionally mislead you on a single deal. Chased hard enough, it can make you a worse investor — trading patient wealth for fast-looking returns, over and over, because the scorecard applauds the churn. The number stopped being a mirror and started being a steering wheel.

So should we throw IRR out? No — and this is the part that matters.

IRR isn’t evil. It’s a tool that answers a narrow question well. Speed genuinely matters — money returned early is money you can’t lose to a bad tenth year, and a dollar sooner is worth more than a dollar later. IRR captures something real. The failure was never the number. The failure is letting one number think for us.

The mature investor never reads IRR alone. He reads it next to the equity multiple, and next to the hold period, and lets the three of them argue with each other. A high IRR and a low multiple tells one story — fast, but small. A modest IRR and a big multiple tells another — patient, and rich. Neither is good or bad until you know which one you actually want.

And here’s the quiet skill, the thing worth taking with you. When a sponsor leads with only his IRR — when that’s the number he puts up first and lingers on… he’s telling you something. Maybe about the deal. Maybe about himself. The investor who knows to ask “and what is the multiple?” has, in five words, separated the people who understand their own returns from the people merely quoting them.

The number was never the problem. Letting the number think for you. That’s the problem. And the moment you stop, you can see the deal clearly again.

That’s the work we do at Alkaline Advisors. We never let a single number carry a decision. We read the IRR, the multiple, and the hold together, and we show you what the pitch deck’s headline return is quietly leaving out. Because the deal is won or lost in the structure and the downside, not the headline return.