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The time-weighted return is a valuable tool for determining the Compare the performance of different investment portfolios. In this article you will learn what time-weighted returns are, how to calculate them, when they are useful and what their advantages and disadvantages are.
You will also learn how the time-weighted return differs from other return calculations such as the simple or money-weighted return.
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The Time-weighted return (TWR) is a method for calculating the return on an investment. It Measures the success of an investment strategy, regardless of when and how much money in a specific period invests was. Therefore, it is particularly useful when there are multiple cash flows, for example, when you pay money in or out frequently.
The time-weighted return gives you a Clear picture of how your portfolio has developedwithout the results being distorted by further payments in or out.
To calculate the time-weighted return for your portfolio, follow the steps below. If after the Step-by-step guide If you have problems with the calculation, you will find a practical example with a calculation example below.
If you would like to calculate the TWR and other key figures easily and conveniently at the click of a mouse, you should take a look at the free tool Portfolio Performance View
Otherwise, here is a practical example for calculating the TWR performance:
Say, you invest CHF 1,000 in a portfolio and after one month it has a value of CHF 1,050. Now you invest another CHF 2,000 and at the end of the next month the entire portfolio is worth CHF 3,150. The Calculation of the time-weighted return would look like this:
For the first month the simple return would be (CHF 1,050 / CHF 1,000) = 1.05 or 105 %. Since you are calculating the final value of the first month, you subtract 1 and get 0.05 or 5 %.
In the second month you invest another CHF 2'000, which brings your total investment to CHF 3'050. At the end of this month, the value of your portfolio is CHF 3'150. Therefore, the simple return for the second month is (CHF 3'150 / CHF 3'050) = 1.0328 or 103.28 %. Again, you subtract 1 to get 0.0328 or 3.28 %.
To get the TWR, you now multiply the values of the simple returns for each month and subtract 1: (1.05 × 1.0328) - 1 = 0.083 or 8.3 %. You can also simply add the percentages: 5 % + 3.28 % = 8.3 %.
Your time-weighted return over this two-month period is 8.3 %.
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The TWR is particularly practical for Evaluate the performance of an asset manager or fund manager. Since the TWR takes into account the times when receipts and payments occur, you can assess how well the manager has managed the funds regardless of the cash flows.
Furthermore, the TWR is useful for Evaluation of your own investment performance. You may want to compare different strategies or see how your portfolio has developed over time. With the TWR you can do just that.
The time-weighted return has many Advantages.
The TWR allows you to directly compare the performance of different investments, managers or strategies. This is especially important if you are looking for ways to improve your investment strategy.
Despite these advantages, the TWR also has some Disadvantages.
In the calculation of the fair value return, the simple rate of return (ER) a fundamental component. In addition to the simple return, there is also the money-weighted return. All three types of calculation have their specific use cases and can be useful in different situations.
In the above example, the initial value is CHF 1,000 and the final value is CHF 3,150. Therefore, the simple return: (CHF 3'150 / (CHF 1'000 + CHF 2'000)) = 1.05 or 5 %.
When you have money-weighted yield (GWR) it gets complicated, because you have to relate the net cash flow for each period to the return you are looking for. For the return, you have to solve this equation:
-1'000 / (1 + r) + -2'000 / ((1 + r)^2) = -3'150
To solve this equation you need Financial functions such as the IRR (Internal Rate of Return) in a spreadsheet programme. For illustration, you can use the GWR in Google Sheets with the IRR function and use the returns of the other calculation types as a comparison:
| Cash flow | Date | GWR | ER | TWR |
|---|---|---|---|---|
| CHF - 1'000 | 01.01.2023 | 4 % | 5 % | 8,28 % |
| CHF - 2'000 | 01.02.2023 | |||
| CHF 3'150 | 01.03.2023 |
So you can see that the different methods of calculating returns give very different results.
Why is that important for you? If a financial service provider advertises its rate of return, you should know how it was calculated and whether figures have been glossed over. In order to give meaning to the yield claim, the method must be clearly declared.
The simple return is the profit (or loss) divided by the initial investment amount. It indicates in relation to the initial value, how much your investment has changed in absolute terms. The simple return is suitable for simple investments with only one deposit and withdrawal.
The money-weighted return (money-weighted return, MWR) captures the individual investment experience of an investor. The MWR takes into account when and how much money flows into an investment. If you have invested a large sum of money at a favourable time, this is taken into account more in the MWR than in the TWR.
The TWR, simple yield and MWR have differences that are reflected in their Strengths and weaknesses show:
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In this article you have learned a lot about time-weighted returns and other ways of calculating the performance of your investment strategy. You now know, How to calculate the time-weighted rate of return and where it has its strengths and weaknesses.
However, as with everything in finance, there is no "one-size-fits-all" tool. The time-weighted return, simple return and money-weighted return all have their specific use cases and offer Different insights into the performance of your investments.
Do not blindly trust other people's calculations! Financial service providers are very familiar with different calculation methods and therefore know exactly which method can put their performance in a better light. Therefore, pay attention to the method used to calculate returns when someone advertises their returns.
Feel free to share your thoughts and questions in the comments section!