Time Weighted vs. Money Weighted Returns
There are 2 ways to report past performance. Each has a purpose in investment management. As I mentioned in my last blog – it is about asking the right questions and using the proper method depending on the question at hand.
Let’s start with some proper definitions.
Money Weighted Return:
Same as the internal rate of return (IRR); the growth rate that will link the ending value of the account to its beginning value plus all intermediate cash flows.
Time Weighted Return:
The compound rate of growth over a stated evaluation period of one unit of money initially invested in the account.
Given that we always provide both, let me explain both in greater detail. I’ll begin with the Money-Weighted Return (MWR).
As the name implies, the Money Weighted Return weighs returns based on how much (or how little) money was in the account at the time the return was generated. What this means to the investor is simply – the MWR answers the question “how am I doing toward my goals?”.
The MWR gets:
• A boost
o when contributions are made before the account goes up
o when distributions are made before the account goes down
• A reduction
o when contributions are made before the account goes down
o when distributions are made before the account goes up.
While your advisor is responsible for whether the account goes up or down due to market performance, the investor is responsible for how much goes into or out of the account, and when. And so, using only the MWR to evaluate your investment performance –will sometimes leave you very happy with your advisor when they are benefiting from your good timing of contributions or withdrawals, or, it may actually cause you to fire your advisor when the poor performance is the direct result of the timing of your contributions/distributions and the underlying portfolio is performing very well.
Unlike the MWR, the Time Weighted Return (TWR) is a total misnomer. It doesn’t weight time at all. The TWR exists to solve for the issues noted above with the MWR, and answer the question, “How is my portfolio manager doing, exclusive of the timing of contributions and distributions?”
Depending on how much contribution and distribution activity there is in an account – these numbers can be wildly different. They can even have different signs – where one return calculation is a gain and the other is a loss.
Suppose you deposit $100,000 into your account and in the first year the portfolio returns 10%, and you finish with $110,000. You feel great about this and so you add $100,000 to the account. In the second year, the account drops by 8% and you finish the year with $193,200.
The total investment: $200,000
The final balance: $193,200
Net Gain/(Loss): ($6,800)
Money Weighted Return: -3.40%
Formula: “($193,200/$200,000) -1” or “(Ending/Invested) -1”
Time Weighted Return: 1.20%
Formula: “[(1+.10) x (.92)] -1” or “(1+Year 1 %) x (Year 2 %) -1”
In this example, the advisor is actually up over the 2-year term – up 10% then down 8%. the investor however, is down – they lost money because they added before the portfolio lost value.
We don’t endorse one over the other – that would be like always using a hammer and never a screwdriver. We use what the job calls for – and try to understand which question is being asked before we attempt to provide an answer.
It should be noted that the market is on thin ice the past couple days with President Trump reigniting the trade-war over the weekend. Its scary how much is hinging on the outcome of one set of problems. The world has a whole host of others that don’t really care what the outcome of the trade talks is. We are still carrying plenty of cash in our portfolios – and earnings reports for most of our holding have been strong. A client once told me “I’ve never found panic to be useful.” And I couldn’t agree more. We are patient and methodical – it has served us well.
Chief Investment Officer
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