Why Return Calculation Matters
Ask most investors their portfolio return and they'll give you a vague answer. "I think I'm up about 15%?" This imprecision is a problem - you can't improve what you can't measure.
The challenge is that calculating returns gets complicated once you start adding or withdrawing money. A simple "ending value minus starting value" calculation doesn't account for when you made deposits or withdrawals.
That's why there are two main methods: Time-Weighted Return (TWR) and Money-Weighted Return (MWR). Each answers a different question:
- TWR: "How well did my investment strategy perform?"
- MWR: "What was my actual personal return given when I invested?"
The Core Difference
TWR treats a $1,000 deposit the same whether it happened before a market boom or bust. MWR weights returns based on how much money was actually invested at each point in time.
Time-Weighted Return (TWR)
Time-Weighted Return measures investment performance independent of cash flows. It answers: "If I invested $1 at the start and made no changes, what would it be worth now?"
How TWR Works
TWR calculates returns for each sub-period between cash flows, then compounds them together:
TWR Formula
TWR Example
You start with $10,000. After 6 months, it's worth $11,000 (+10%). You deposit another $5,000. Six months later, your $16,000 is worth $17,600 (+10%).
| Period | Start Value | End Value | Return |
|---|---|---|---|
| First 6 months | $10,000 | $11,000 | +10% |
| Second 6 months | $16,000 | $17,600 | +10% |
The timing of your $5,000 deposit doesn't affect TWR - it shows pure investment performance.
When TWR is Useful
- Comparing your performance to benchmarks (S&P 500, etc.)
- Evaluating fund managers who don't control cash flows
- Assessing your investment strategy over time
- Professional performance reporting (GIPS standard)
Money-Weighted Return (MWR/IRR)
Money-Weighted Return (also called Internal Rate of Return or IRR) accounts for when you made deposits and withdrawals. It reflects your actual experience as an investor.
How MWR Works
MWR finds the discount rate that makes the present value of all cash flows equal to the ending value:
MWR/IRR Concept
MWR Example - Good Timing
Same scenario as above, but now let's see how your $5,000 deposit affected your personal return:
| Event | Amount | Timing |
|---|---|---|
| Initial investment | $10,000 | Day 0 |
| Deposit | $5,000 | Month 6 |
| Final value | $17,600 | Month 12 |
Slightly lower than TWR because your $5,000 only experienced half the year's gains.
MWR Example - Bad Timing
Now imagine the opposite: the market drops 10% in the first half, you deposit $5,000, then it rises 22% in the second half.
| Period | Start Value | End Value | Return |
|---|---|---|---|
| First 6 months | $10,000 | $9,000 | -10% |
| Second 6 months | $14,000 | $17,080 | +22% |
MWR ≈ 14.3%
MWR is higher because you had more money invested during the good period!
TWR vs MWR: Side-by-Side Comparison
Time-Weighted Return (TWR)
Eliminates the impact of cash flows. Shows how $1 would have grown regardless of deposit/withdrawal timing.
- Industry standard for benchmarking
- Required for GIPS compliance
- Ignores investor behavior
- Harder to calculate manually
Money-Weighted Return (MWR)
Accounts for timing and size of all cash flows. Shows your actual personal return.
- Reflects your real experience
- Same as IRR calculation
- Rewards/penalizes timing
- More intuitive concept
When to Use Each Method
| Scenario | Recommended Method | Why |
|---|---|---|
| Comparing to S&P 500 | TWR | Fair comparison - S&P doesn't have your cash flows |
| Evaluating a fund manager | TWR | Manager doesn't control when you invest |
| Calculating your personal return | MWR | Reflects your actual money made/lost |
| Retirement projection | MWR | You care about real dollars, not abstract % |
| Tracking strategy effectiveness | TWR | Isolates investment decisions from timing luck |
| Complete portfolio analysis | Both | Each tells a different important story |
Use Both Methods
The best portfolio trackers show both TWR and MWR. If your MWR is significantly lower than TWR, you may have poor timing (buying high, selling low). If MWR is higher, your timing was good.
Other Return Metrics You Should Know
CAGR (Compound Annual Growth Rate)
The annualized return assuming steady growth. Useful for comparing investments over different time periods.
CAGR Formula
Total Return
The complete return including price appreciation AND dividends/distributions. Always use total return, not just price return.
Risk-Adjusted Return (Sharpe Ratio)
Measures return per unit of risk. A higher Sharpe ratio means better risk-adjusted performance. Useful for comparing strategies with different volatility.
Common Mistakes to Avoid
1) Ignoring dividends - use total return, not price return.
2) Comparing MWR to benchmarks - use TWR instead.
3) Forgetting fees - include all costs in your calculations.
4) Looking at single periods - long-term trends matter more.
Frequently Asked Questions
Get Accurate Portfolio Returns
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