The time weighted rate of return is a measure of how well a portfolio has performed over a particular period of time. It is useful when comparing your portfolio to benchmark figures or the performance of other investors. However, unlike the money-weighted rate of return, it does not take into account any cash flow differences that may affect your returns.
The Time Weighted Rate of Return calculates the compound growth rate of a portfolio by breaking it into sub-periods. It multiplies the returns of each sub-period by each other to reflect the effects of compounding.
It eliminates the distorting effect of frequent deposits and withdrawals to present a more accurate picture of your portfolio’s performance.
Unlike the money-weighted rate of return, which can be affected by cash flows in and out, the time weighted rate of return is not sensitive to withdrawals or contributions.
This method is especially helpful for investment managers who are not able to control the timing of cash flows in and out of their funds. In this instance, the time-weighted rate of return can provide a better measure of the actual performance of an investment manager than the internal rate of return (IRR).
Calculating Time Weighted Rates
To start with, you must create sub-periods for periods wherein cash was added to the portfolio or removed from it. To do this, you must mark the start of each sub-period based on when you made your first deposit or withdrawal of cash.
Next, you must subtract the starting balance of each sub-period from the ending balance to arrive at your final balance for that period. Then, you must divide this sum by the total starting balance plus the cash flow in each sub-period for that period. Then, you multiply the result by the total number of sub-periods to get your time weighted rate of return.
You will then need to calculate the total return in each sub-period for the period in which you made a deposit or withdrawal. You must then add these results together to arrive at your final total return for the period in which you made a cash deposit or withdrawal.
The Time Weighted Rate Of Return Explains How It Works
In order to use the time weighted rate of return to calculate your portfolio’s overall rate of return, you must make sure that all the sub-periods and intervals are similar. You can do this by ensuring that the sub-periods and intervals have a similar duration and the investments in each sub-period are all reinvested in the portfolio.
The time weighted rate of return also breaks down your portfolio’s total return into corresponding sub-periods, which are each represented by a different return. This allows you to compare your portfolio’s overall rate of return with other portfolios and fund managers.
This method is a great way to compare your portfolio’s overall return with other investment portfolios. However, it is not the best way to compare it with your own personal returns. The time weighted rate of return can also lead you to overestimate your gains when compared to the money-weighted rate of return, if you have made too many deposits or withdrawals in the past.