“Time Weighted Rate of Return” (TWRR) and “Money Weighted Rate of Return” (MWRR) are measurements used to assess an investor’s portfolio.
In the simplest of terms, TWRR will measure your portfolio’s performance only by assessing the time measurement period. MWRR, in addition to considering the measurement period, also takes into account the cash flow.
Let’s take a closer look and understand how you can measure your portfolio’s performance in a more professional manner.
What Is Time Weighted Rate Of Return?
As mentioned above, TWRR will measure your portfolio’s performance simply by taking into account the time periods, segregated by cash flow dates, you’ve held such an investment. It is the preferred and purest calculation method available.
TWRR will not take into account cash flow or movement into and from your account. Exclusion of capital flows gives you a more precise assessment of how well your investments have performed over time.
TWRR is useful in comparing your portfolio’s performance against other funds, indexes and industry benchmarks to ensure your investments are performing well, relatively. TWRR will focus entirely on performance while ignoring any impact of cash flow decisions and as such implied market timing.
Let’s take an example to better understand the usefulness (and shortcomings) of TWRR. Investors A and B both invest $10,000 in a fund in July. Three months later the fund has achieved a growth rate of -5%. Investor A doubled his initial investment, $10,000, and Investor B withdrew half of her initial investment, $5,000. The fund subsequently returns +5.26% which get’s it back to 0% performance for the six month period.
Investor A ended with $20,526 which is a positive rate of return, above $20,000. Investor B ended with $4,737 which is a negative rate of return, below $5,000. But both, when removing cash flows, experienced -5% and +5.26% and subsequent 0% compounded rate of returns.
How To Calculate TWRR?
As mentioned above, TWRR is essentially a calculation of the returns on investment that any given investment manager generates over specific periods of time. These periods are then geometrically linked or compounded.
The scientific formula used to calculate TWRR is as follows:
TWRR = [(1+HP1) x (1+HP2) x (1+HPn)] – 1
In layman’s terms, if you want to calculate the TWRR, you can do so by finding the return for each sub-period. This can be done by subtracting the sum of the starting balance and the cash flow, from the ending balance to calculate periodic profit(loss). The result of this is divided by the sum of the starting balance and cash flow.
As you can tell from the above, understanding the calculations is not easy for a layman, and speaking to reputable financial advisors can go a long way in helping investors understand these mechanisms better.
What Is Money Weighted Rate Of Return?
MWRR has the same function as TWRR in that it measures the performance of your portfolio but takes cash flow amount and timing into account.
In measuring your account’s performance, MWRR will account for the overall duration of the investment (like in TWRR), the timing of the cash flow, the amount of the cash flow, and the performance of underlying investments in your account.
Just something to note; cash flow includes any assets, cash, or securities that you move into or out of your account. This could even include transactions that are not related to current portfolio investments.
MWRR is much more informative in helping you determine whether your investments are keeping you on track to meet your financial goals. MWRR will consider, unlike TWRR, that there are other factors involved in assessing the performance of an account.
For example, the timing of investment is different for different investors, even if it's in the same stock. Another example is the amount of investment made as some investors will buy more units of stock when there is a discount opportunity, whereas others may be purchasing the same stock when the price is high and are not able to buy the same amount of stock.
How To Calculate MWRR?
Calculating your account’s MWRR is a lot more difficult than it is to calculate TWRR. Not only would you need to know the formula and working, but performing such a calculation requires a financial calculator or software.
Even though MWRR calculators are available online, it still takes a certain level of understanding to properly calculate MWRR. Financial advisors are able to do so with ease as they know the mechanics of the calculation and it's the same formula as calculating the internal rate of return.
For the layman, however, it gets a lot more difficult. You can’t just do it with paper and pen, and the calculation gets harder if the cash flows for each period are different.
In any given scenario, you will need a financial calculator or specialized software (like Microsoft Excel), and a working knowledge of such financial formulas in order to calculate the MWRR accurately.
What Are The Differences Between TWRR & MWRR?
TWRR is the CFA Institute's preferred method of performance measurement as it is the most comparable and least distorted calculation measure. Furthermore, market timing is academically proven unsound and thus professionally discouraged and therefore measuring performance regardless of how much money was in the account is preferred. Why should it matter how well your investment manager does whether you have $100,000 or $10,000,000 with him?
If your investment manager has discretion of when to add and withdraw money or you wish to see the implications of your cash flow timing whether due to circumstance or emotional or cognitive behavioral finance biases then a MWRR will be a good measure of performance.
Consult With A Wealth Management Expert Near You!
Rather than choose one of the two, both can be used to assess your account's performance and you can be one step closer to reaching your financial goals. In fact, there are many other factors that can help you assess your account’s performance.
It is always advisable to consult with a financial advisor or wealth management expert if you are seeking to better understand the returns you are generating on your investments. Trusted and reputable companies such as Eastport Financial Group Inc, located in Halifax, NS, specialize in financial advisory services and can help guide you in the right direction.