When you are looking to determine your portfolio’s “pure” performance, one of the best metrics to use is the time-weighted return (TWR). What does “pure” mean though? And what does time-weighted actually mean?
The most commonly used return measure is the Internal Rate of Return (IRR), also known by its more descriptive name of Money-weighted return (MWR). It measures your portfolio’s actual performance between two dates, and it includes all cash movements. Because of this, the MWR of a portfolio can be crucially affected by both the size of your deposits (or withdrawals) and their timing.
If you are lucky enough to invest or divest at the right times during the life of your investment, your MWR can shoot up drastically. On the other hand, the TWR compensates for the number of deposits and withdrawals you make to your account.
TWR: an example
Say you invest $1,000 in a stock on 1 January 2019, and the stock price grows by 50% from January to June. You’re so glad with that performance that you put another $10,000 dollars into that stock in June. But then, the price goes down 10% between June and the end of the year.
Since the stock price went up 50% for the first half of the year and then down only 10% the second half, your TWR is 35%. In contrast, your MWR is a 9% loss.
How come? Most of your money missed the 50% rise. And when you did invest it, the price declined and you ended up with less money than your total investment. The timing of that $10,000 contribution was significant.
In conclusion, The MWR can be the most appropriate metric to determine how your portfolio has performed relative to your other assets. But it also shows how your decisions (when and how much to invest) have impacted the “true” return of the asset. In other words, your stock performed well through the year (+35%), even though your investment didn’t (-9%).
With Exirio, you will see both MWR and TWR automatically for all your investments, as well as for your overall wealth. Happy tracking!