Investing is an important way to grow wealth, but it can be complicated, especially when it comes to measuring investment performance. Two common measures of investment returns are time-weighted return (TWR) and money-weighted return (MWR). While both measures look at investment returns, they use different methodologies, which can lead to different results. Understanding the difference between time-weighted return and money-weighted return can help you evaluate your investment performance effectively and make better investment decisions.
Time-Weighted Returns (TWR):
Time-weighted return (TWR) measures the performance of an investment by focusing on the returns generated by the portfolio manager. TWR assumes that you invested your money at the start of the investment period and didn’t make any additions or withdrawals until the end of the period. TWR looks at the returns generated by the portfolio manager over that period to evaluate their performance. The calculation does not take into account cash inflows or outflows of the fund during the period, which gives a more objective measure of performance.
Money-Weighted Return (MWR):
Money-weighted return (MWR), also known as Internal rate of return (IRR), evaluates the investment performance by analyzing the returns on your investment. Unlike TWR, MWR takes into account the timing and size of cash flows and assumes that the investor controls the timing of cash inflows and outflows. MWR measures the actual rate of return that your investment provided by using the amount of money invested and the holding period. It accounts for the timing of cash flows, making it more relevant for investors with regular contributions or withdrawals compared to TWR.
Understanding the Difference:
The difference between TWR and MWR becomes more pronounced when investors make significant cash inflows or outflows during the investment period. The TWR assumes all the money invested is there throughout, and any changes will be based on the actions of the portfolio manager. Whereas, the MWR incorporates factors such as the timing and size of the payments that were not accounted for in TWR.
TWR would be more beneficial when evaluating the performance of a portfolio manager, while MWR would be more appropriate when evaluating the investment return generated on your investment. While MWR takes an investor’s cash flows into account, it may still not reflect the performance of an entire portfolio due to its sensitivity to the amount and timing of cash flows.
Conclusion:
In conclusion, investing is an essential aspect of wealth creation, but it can be challenging to evaluate performance. Time-weighted return (TWR) measures the performance of a manager, while money-weighted return (MWR) measures the actual rate of return generated on your investment. The difference in methodology between TWR and MWR makes it possible to use them differently when evaluating the performance of an investment or a portfolio. Knowing the differences between the two measures will enable you to select the appropriate evaluation method. Ultimately, the goal is to maximize investment returns while minimizing risk, and understanding these measures’ differences will help you achieve these goals.
