- Ref:: sharesight
- Title:: Time-Weighted vs Money-Weighted Rates of Return
- Author:: David Olsen
- Year of publication:: 2021
- Category:: Blog
- Topic:: #topic.investment
Notes from reading
the difference between time-weighted versus money-weighted (or dollar-weighted) returns when calculating portfolio performance
Time-Weighted: Time-weighted rates of return do not take into account the impact of cash flows into and out of the portfolio.
Time-weighted rates of return attempt to remove the impact of cash flows when calculating the return. This makes it ideal for calculating the performance of broad market indices or the impact of a fund manager on the performance of an investment. Time-weighting is important in this context as fund managers do not control the timing of cash flows into and out of their fund – investors control that – so it is not reasonable to include that effect when evaluating the performance of the fund manager.
Money-Weighted: Money-weighted rates of return do take into account the impact of cash flows into and out of the portfolio.
money-weighted rates of return calculate investment performance taking account both the size and timing of cash flows in and out of an investment portfolio, placing a greater weight on periods when the portfolio size is largest
For the vast majority of investors a money-weighted rate of return is the most appropriate method of measuring the performance of your portfolio as you, the investor, control inflows and outflows of the investment portfolio.
Time vs Money-weighted - an example
To help explain the difference between time-weighted and money-weighted returns, let’s imagine an investor who made three trades in a particular stock over a period of two years. Let’s assume that:
- On December 1st 2015, the investor invested $1,000 to buy 1,000 units of StockABC at $1.00 per share
- On December 1st 2016, they bought another 1,000 units of StockABC at a price of $2.00 per share (spending $2,000)
- On December 1st 2017 the investor sold their entire holding of 2,000 StockABC shares after the price fell to $1.25
In this scenario the investor lost $500 in this portfolio over the two years.
Here’s how the return numbers for each of these performance methodologies differ in this instance:
- Money-weighted return: -12.77% p.a.
- Time-weighted (CAGR) return: 11.80% p.a.
Despite the investor losing money on the portfolio, the time-weighted return was positive. This is because the time-weighted return is only measuring the underlying performance of the shares held in the portfolio and not the actions of the investor buying into or out of those shares (inflows and outflows) or the impact of the size of those actions over the period being measured.