Time-weighted rate of return

Time-Weighted Rate of Return

The time-weighted rate of return (TWRR) is a method used to measure the performance of an investment portfolio over a specific period of time. It is a widely accepted metric in the finance industry and is used by investors, financial advisors, and fund managers to assess the success of their investment strategies.

Calculation of the Time-Weighted Rate of Return

The TWRR calculation takes into account the effect of cash flows on the overall return of the portfolio. It eliminates the impact of external factors such as additional investments or withdrawals made during the investment period. This allows for a more accurate assessment of the performance of the underlying investments.

The formula for calculating the TWRR is as follows:

TWRR = (1 + R1) * (1 + R2) * ... * (1 + Rn) - 1

Where R1, R2, ..., Rn represent the individual returns for each sub-period within the investment period. The returns are compounded using the geometric mean to account for the different lengths of the sub-periods.

Time-weighted rate of return
Time-weighted rate of return
Time-weighted rate of return
Time-weighted rate of return

An Example of the Time-Weighted Rate of Return

Let's consider an example to better understand how the TWRR works. Suppose an investor has a portfolio with the following returns over a three-year period:

  • Year 1: 10%

  • Year 2: 15%

  • Year 3: 5%

To calculate the TWRR for this portfolio, we use the formula mentioned earlier:

TWRR = (1 + 0.10) * (1 + 0.15) * (1 + 0.05) - 1 = 0.3225 or 32.25%

This means that the investor's portfolio has achieved a time-weighted rate of return of 32.25% over the three-year period, after accounting for the impact of cash flows.

The TWRR is a useful metric as it allows investors to evaluate the performance of their investments without being influenced by external factors such as deposits or withdrawals. It provides a more accurate representation of the returns generated by the underlying investments, enabling investors to make informed decisions about their portfolios.

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