Time weighted return vs money weighted return
There are two basic performance calculation methods used by the financial industry and RBC Dominion Securities – time weighted return (TWRR) and dollar weighted return (DWRR). Both have their benefits, but each method is designed to measure different aspects of your portfolio’s overall performance.
A Time Weighted Return measures a fund’s or portfolio’s compound growth rate by breaking a period into sub-periods. This allows for a more accurate representation of your returns compared to other metrics because it eliminates distortions caused by frequent deposits and withdrawals.
TWR can be useful when comparing the performance of mutual funds to that of other funds. It helps separate the effect of external cash flows from the performance of the mutual fund manager’s management of that portfolio.
It also removes the possibility of being misled by a fund’s annual returns time weighted return vs money weighted return when a large cash flow from that fund occurs during a certain period. However, a time weighted return is not suitable for comparing the performance of different investment portfolios.
This is because the time weighted return does not take into account the timings of cash flows into and out of an investor’s account. It does not look at how long a cash flow occurred and does not consider whether it was a positive or negative one.
On the other hand, a money weighted return takes into account both the size and timing of cash flows into and out of an investor’s portfolio. It does this by finding the interest rate or return that would have to be paid to obtain the actual ending value of the investment. This approach is more useful for communicating with clients about the true results of their investments, as it shows them the actual amounts that are invested versus how much is actually received.
Another benefit of a money weighted return is that it allows the fund manager to compare his or her fund’s performance to other funds in the same sector. This can be useful for determining how well the fund manager is performing or for assessing whether a change in fund strategy may be necessary.
In addition, a money weighted return can provide useful information about a fund’s investment performance and helps investors make informed decisions about their portfolios. This information can help them decide if they want to purchase additional shares or whether they wish to switch out of a particular fund or sector altogether.
Both a time weighted and a money weighted return are valid and acceptable calculation methods. Both can be used to calculate your portfolio’s performance and both are a great way to communicate with your clients about the real outcomes of their investment.
DWRR can heavily change depending on when large cash flows in and out of an investment occur.
Similarly, a time-weighted return can also be heavily changed when a large cash flow from one fund is transferred to another fund in the same sector. This can skew the overall return of an investment and can be difficult to reconcile with a simple yearly average.