Objective: Compensatory strategies such as assistive technology, external reminders, and environmental cues may help support instrumental activities of daily living (IADLs) and independence. However, functional ability is most often evaluated in clinical settings where everyday compensation cannot be readily observed. The present study used a novel, real-world evaluation of everyday activities (prospective memory, household chores, complex IADLs, and planning tasks) to examine the impact of compensation. Method: Fifty community dwelling older adults were recruited with cognitive status ranging from healthy to mildly impaired. Participants completed a battery of validated performance-based and cognitive tasks, an IADL questionnaire (also completed by an informant), and real-world activities carried out in their own homes. Results: The real-world evaluation demonstrated adequate interrater reliability (intraclass coefficient = 0.92) and construct validity (r = 0.55). Compensation improved real-world task outcome on prospective memory and household chores tasks. Further, cognition emerged as a moderator between compensation and prospective memory task outcome. Participants' ratings on an IADL questionnaire were related to real-world and performance-based functioning whereas informants' ratings were related to performance-based tasks and cognition. Conclusions: Our results suggest that proxy measures of functional ability (i.e., performance-based, cognitive, and IADL questionnaire measures) do not fully capture the complexity of real-world performance for nondemented community dwelling older adults. Compensation appeared to improve prospective memory performance, particularly for individuals with average to low average cognitive abilities. A difference in IADL questionnaire ratings suggest that participants may be better able to judge their real-world performance than informants. General Scientific Summary Neuropsychologists are often asked to determine whether a person can safely complete everyday tasks such as cooking, bill payment, and medication management independently. However, it is not well understood how sufficient clinic-based tools for assessing everyday tasks are at accurately estimating a person's functioning in the real-world. Results from the current study suggest that current clinic-based tools are limited because they do not account for a person's ability to compensate for cognitive weaknesses in the real-world. For example, a person may use an alarm to remind them to do something in the future. Targeted interventions to improve and maintain compensation at the earliest stages of cognitive change may enhance independence.