VAN vs TIR: Which one to choose for your investments and why many get it wrong

If you invest money, you have heard of NPV (Net Present Value) and IRR (Internal Rate of Return). But here comes the uncomfortable part: these two indicators can completely contradict each other, and most investors do not know how to resolve this.

The real problem: positive NPV but low IRR ( or vice versa )

Suppose you are comparing two projects:

• Project A: NPV of $5,000 but IRR of 8%
• Project B: NPV of $2,000 but IRR of 15%

Which one do you choose? Here's the catch. The NPV tells you how much net profit in real money you will get. The IRR tells you the rate of return percentage. They do not measure the same thing.

VAN: The money you will actually earn

The NPV responds: “How many net dollars will I have in my pocket after accounting for inflation and risk?”

Simplified formula: Sum of future cash flows ( adjusted for risk ) - Initial investment

Real example: You invest $10,000 today. You will receive $4,000/year for 5 years. With a discount rate of 10%:

• Present value of cash flows = $15,162
• Less initial investment = $5,162 net profit
• VAN = positive → good investment

Critical limitation: The NPV depends on the “discount rate” that you choose. Change that and everything changes. Also, ignore whether the project is flexible or if there are unexpected risks.

TIR: The return percentage it promises

The IRR asks: “What annual rate of return would reach equilibrium?”

If the IRR is greater than your cost of capital, the project is profitable.

The issue of the IRR:

1. There can be multiple IRR for the same project (guaranteed confusion)
2. Assume that you will reinvest the cash flows at the same percentage (rarely happens in reality)
3. It does not work well with irregular cash flows or projects with intermittent losses.
4. A small project with a 50% IRR is NOT better than a large one with a 12% IRR if the latter generates more absolute money.

What to do when they contradict each other?

Golden rule: In case of conflict, trust the NPV more if you are assessing absolute profitability. Trust the IRR if you are comparing similar-sized projects.

Even better: use both + other indicators:

• ROI (Return on Investment)
• Recovery period (how long does it take to recover the investment)
• Profitability Index (gain per dollar invested)

The practical conclusion

Don't choose only by VAN or only by TIR. Numbers can lie if you ignore:

• The actual volatility of the project
• Economic and regulatory changes
• Your personal risk tolerance
• The size of your wallet and diversification

A positive NPV does not guarantee success if the project is risky. A high IRR is useless if the investment is illiquid. Combine the metrics, question your assumptions, and never rely on a single number.