How do I calculate the performance of my portfolio? What is the difference between time weighted and dollar weighted performance calculations?
Investment performance seems like it should be easy to measure and even easier to understand, but investors often find that interpreting performance measurements can be confusing. One reason for the confusion is that the financial industry standards for performance reporting are designed to accurately measure the “performance” of an investment manager and not necessarily the personal performance of an individual. In this article we’ll clarify these differences to help you better understand your own performance report and why your Asset Class Investing portfolio uses a particular method.
The two most common ways to report performance are dollar-weighted rate of return (DWRR), and time weighted rate of return (TWRR). While dollar-weighted performance is weighted by the amount of dollars in an account at the beginning and end of the performance period, time-weighted performance is based on
the amount of time the dollars were invested. A dollar-weighted rate of return is highly influenced by the timing of cash flows into and out of your account.
Therefore, the return is higher when more money is invested during periods of greater price appreciation. This method is more “investor-centric” because it does not isolate the funds’ performance from an investor’s luck or timing.
Time-weighted rate of return measures how much your investments returned on average, without the influence of the size or timing of contributions. You can think of TWRR as the return on your portfolio, assuming $1 invested at the beginning and ignoring cash flows in and out. This method is used to compare investment choices or strategies vs. appropriate benchmarks. Since investment managers usually have no control over client cash flow decisions, TWRR is the only fair way to evaluate managers versus their benchmarks.
Let’s run through the return calculation for a sample, hypothetical investor. Please note, this example is not indicative of any actual investment product or strategy.
Four years ago, this investor put $200,000 in a portfolio aligned with her long-term goals. This portfolio then grew by 10% a year for 4 years. At the start of the 5th year the investor received a large inheritance, worth $1,000,000, and added it to the account. During this same year the market happened to decline, and the portfolio lost 10%. The portfolio value historically would look like this: