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The money-weighted return is a useful tool to track your personal investment performance. In this article you will learn what the money-weighted return means in detail, how you can determine themwhen it applies and which advantages and disadvantages it holds.
You'll also learn how money-weighted returns differ from other measures of return, such as simple and time-weighted returns. Are you ready to deepen your financial knowledge? Then let's get started!
The money weighted return (MWR) is a method of calculating the return on an investment. It measures your investment experience as an investorby taking into account when and how much money you invested and at what point in time. Therefore, MWR is particularly useful when there are multiple cash flows and you are regularly depositing or withdrawing money.
sThe money-weighted return gives you a detailed picture of this, how good your personal investment decisions wereby including deposits and withdrawals and their timing in the calculation.
Calculating the money-weighted return can seem complicated at first, especially when there are many cash flows. In this section you will learn a Step-by-step instructions for calculating the MWR which turns the complexity into a simple calculation. After the tutorial, you can experience the theory in practice with an example. Here is the guide to the Calculation of the money-weighted return in three steps:
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Here is the practical calculation example:
You invest CHF 1,000 in a portfolio and after one month it is worth CHF 1,050. You decide to invest another CHF 2,000 and at the end of the next month the whole portfolio is worth CHF 3,150. The calculation of the money-weighted return looks like this:
You have been in the first month CHF 1'000 invested and at the end of the month it was CHF 1'050. The cash flow for the first month would therefore be CHF -1'000 (your investment is a payout) and for the second month CHF 1'050 (your portfolio is a deposit).
At second month you invest an additional CHF 2'000 and at the end of the month the value of your portfolio is CHF 3'150. Therefore the cash flow for the second month is CHF -2'000 and for the third month CHF 3'150.
To find the money-weighted return, you need to solve the following equation:
Through Applying the IRR function in a spreadsheet programme you get a MWR of 4 % for this two-month period.
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Although the money-weighted return is more complex to calculate, it gives you a sA personalised view of your investments. Therefore, MWR is particularly useful in the following scenarios:
Although the money-weighted return is useful, it also has its limitations, which you will learn about in the next section.
The money-weighted return provides a Variety of advantagesHowever, it also brings Challenges with. Here are the main advantages and disadvantages:
Now that you have learned about the advantages and disadvantages, you can see a direct comparison with other methods of calculating returns.
As already mentioned, the return on your portfolio is an important indicator of the success of your investment. In addition to the money-weighted return, there are other ways of calculating returns. Each method has its advantages and disadvantages. The two most common other calculation methods are the simple and the time-weighted return.
In the calculation example, the initial value is CHF 1,000 and the final value is CHF 3,150. The simple return in this case would be 5 % (CHF 3,150 / (CHF 1,000 + CHF 2,000)) = 1.05 or 5 %).
For direct comparison, here is the calculation of the time-weighted return using the example from the text. The simple return for the first month is 5 % (CHF 1'050 / CHF 1'000) = 1.05). The simple return for the second month is (CHF 3'150 / CHF 3'050) = 1.0328 or 3.28 %.
To get the time-weighted return, you just have to add both calculated values: 5 % + 3.28 % = 8.3 %.
Comparison of the results of all three yield calculation methods:
| Cash flow | Date | MWR | ER | TWR |
|---|---|---|---|---|
| CHF - 1'000 | 01.01.2023 | 4 % | 5 % | 8,28 % |
| CHF - 2'000 | 01.02.2023 | |||
| CHF 3'150 | 01.03.2023 |
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The Money-weighted return is a useful tool to measure the performance of your investments and calculate the net return.. However, it is important to use them in combination with other metrics and information to get the full picture.
After reading this article, you will have a better understanding of money-weighted returns and how to use them in your investment process. Investing requires patience, discipline and continuous learning, but with the right tools and information you can start on the path to financial success.
Do you have any other questions about the topic or are there any other financial topics you would like to discuss? Feel free to use the comment function!