The differences between money weighted and time weighted returns have been shared below in the tabular form. Let us have a quick look at them:
Table Of Contents
Difference Between Money And Time-Weighted Return
Both money-weighted and time-weighted returns are used to measure an investor's portfolio performance, but they still have certain dissimilarities. While the money-weighted return helps measure an account's performance with respect to the timing and volume of cash flows, the time-weighted rate of return only measures an account's performance over time without considering other elements, such as cash flow.
Key Takeaways
- Time-weighted rates of return and money-weighted rates of return are two methods that are used to measure an investor's portfolio performance.
- The money-weighted return measures an account's performance after considering the timing and volume of cash flows.
- The time-weighted rate of return also measures an account's performance over time but excludes elements such as cash flow.
- MWR reflects an investor's actual investing experience; it is a suitable way to assess how the portfolio has done in relation to its financial objectives.
- TWR is responsible for comparing the investor's portfolio against an index or fund as a benchmark.
Comparative Table
| Key Points | Money-Weighted Return | Time-Weighted Return |
|---|---|---|
| 1. Concept | It is used to measure an investor’s portfolio performance, while also considering the cash inflows and outflows. | It is used to measure an investor’s portfolio performance |
| 2. Weightage | The money-weighted return provides different weights to different period, given the increasing and decreasing cash flows (in/out). | In contrast, the time-weighted rate of return provides the same weights to all periods, given the cash flow is ineffective. |
| 3. Suitability | It is best used by investors to check for and assess the trading activities and decisions they make for an investment as those impact the latter’s performance significantly. | It is a suitable measurement technique for investors if they wish to make comparison between how different funds are performing. |
| 4. Essence | Money-weighted rate of return is the calculation of the rate of return for investors. | The time-weighted rate of return calculates the rate of return of the money managers. |
| 5. Control Over Cash Flow | The money-weighted return best works when an investment manager has complete control over cash flows (inflows and outflows). | Here, the portfolio managers have no significant influence over the amounts invested. Fund managers are an example where they do not have control over the amount added or withdrawn by their clients from the fund. |
What Is Money-Weighted Return?
The money-weighted return (MWR) measures an investor's performance with respect to factors like the size and timing of the cash flow size and the cash flow timing. Since it includes both the investor's specific timing and size of the contribution (and withdrawal), it provides distinctive portfolio measurement values. As the name suggests, the return is weighed on the money involved within a specific period. It is also known as the dollar-weighted or internal rate of return.
The MWRR reveals the rate of return an investor receives through their investments. It reflects an investor's actual investing experience; it is a suitable way to assess how the portfolio has done in relation to its financial objectives. If the money-weighted rate of return is higher than the time-weighted rate of return, it signifies the investor’s successful timing of the market.
The money-weighted return, in short, measures the portfolio’s performance based on investors' trading decisions and the activities they undertake for profit-making. It marks the personal experiences of the investors and helps them check how a trading activity or decision impacts their account. Based on their observation, the investors identify better strategies and decide how to proceed.
The calculation of MWRR can be complex. It sets the present value of the initial investment equal to the current value of the future cash flows. The cash flows include security purchases, sales, cash deposits and withdrawals, dividends, etc. All of the calculations are done based on the period in question.
What Is Time-Weighted Return?
The time-weighted rate of return (TWRR) measures an investor's portfolio's performance over a specified period. TWRR does not consider factors such as the size of the cash flow or the effects of its timing from contributions and withdrawals made in and out of the portfolio. TWRR is responsible for comparing the investor's portfolio against an index or fund as a benchmark. This is because it concentrates on the underlying securities while excluding the effects of the investor's cash flow decisions.
As the name implies, the return is weighted according to the length of each period (time). The whole investment period is divided into numerous sub-periods, and weights are added to each sub-period return when calculating it. The time-weighted rate of return assumes that the investment was constant each day of the measurement period. The geometric linking of the daily valuations produces a rate of return over a long period. The investment portfolio's performance is influenced by the daily changes in the values of the accounts over a period.
This measurement technique allows for assessing a fund’s performance against the fund benchmark and is best used to compare different fund performances.
For example, Stella and Mark made an initial investment of $5,000 each for a year. The market witnessed a downward movement for the first six months, and it noticed an improvement for the other six months. While Stella got worried about her returns, given the market decline in the first six months, she withdrew half of the investment amount; Mark decided to invest some more, expecting a reverse pattern in the future. As a result, the latter took a chance, timed the market well, and received better returns.
Similarities
The similarities between the two concepts include the following:
- Money and time-weighted returns are used to measure the performance of an investment and are, hence, indicators of the success of investments made. The performance affects the profits that are earned through the investments.
- Both help in assessing account performance.
- Past performance is always analyzed through both methods to guide further investments as foundations that pave the way for making such decisions.
