Whether you’re looking to compare portfolios or assess the performance of an investment manager, there are two important metrics that can be used. These are time weighted and money weighted returns. Both have their advantages and disadvantages.
Historically, the industry standard for performance reporting was time weighted. This is still the primary method in use today for evaluating an investment portfolio. However, it is not the only calculation method available and can be inappropriate in some circumstances. Under the new Global Investment Performance Standards (GIPS), firms can replace time weighted return calculations with money weighted returns, as long as certain criteria are met.
A time-weighted return eliminates the effects of cash flows, such as dividends and distributions. This is because a fund manager has no control over the timing of these payments or withdrawals. As a result, it’s more accurate to measure a fund’s performance against a benchmark without incorporating these changes into the return calculation.
On the other hand, money-weighted return calculations take these cash https://www.eastportfinancialgroup.com/keel-magazine/financial-planning/time-weighted-vs-money-weighted-rates-of-returns flow effects into account and are often preferred by regulators. This allows them to better evaluate a client’s performance relative to their individual financial goals and projections.
The basic idea behind a money-weighted return is that it uses a formula to calculate a rate of return for your entire account based on all of your contributions and withdrawals over a given period of time. This allows you to see how your investment capital has grown over time and can help you monitor and track your progress against your goals.
In some cases, you may need a money-weighted rate of return for tax reasons or for GIPS reporting purposes. Using a money-weighted rate of returns can also help you to avoid the pitfalls of time-weighted rates of return.
Generally speaking, a money-weighted return is easier to understand than a time-weighted return because it takes into account the timing of your contributions and withdrawals and can be a more intuitive calculation. It also helps to avoid the pitfalls of time-weighted returns, such as the potential exaggeration of gains and losses due to large withdrawals.
If you are wondering if a money-weighted return is better for your account, it’s probably best to ask your financial advisor about the different types of returns and which one might be more appropriate. Fortunately, Sharesight provides both time-weighted and money-weighted rate of return calculations for your accounts so you can compare how your investment portfolio has performed over time.
A Money-weighted return calculates a compound growth of all the funds that have been invested within a given time period, typically a year. It is often referred to as the Internal Rate of Return or IRR and can be used for many purposes, including calculating your overall return.
When comparing your portfolio’s performance with other investors, you should use money-weighted returns instead of time weighted returns to determine your return on investment. This is because money-weighted calculations will allow you to track your performance against market benchmarks, while time-weighted returns will only show a single rate of return that excludes any cash flow impacts, such as contributions or withdrawals.