What Is Time-Weighted Return?

Most investors want to know if their money is growing, or if the value of their investment is declining. Calculating the time-weighted return can give a pretty clear answer. It looks beyond black-and-white gains and also accounts for money that moves into or out of an investment portfolio.

The time-weighted return can provide an accurate snapshot of your earnings or losses, though the math can be a little tricky. Here’s how it works—and what makes it different from your regular rate of return.

What Is Time-Weighted Return?

A fund’s time-weighted return is considered one of the most accurate ways to see how your investment is doing. It shows the compound rate of growth, which is how much a fund’s value has grown or shrunk since the last time you made a deposit or withdrawal. This timeframe is called a sub-period, and it resets whenever there’s an inflow or outflow of cash.

The time-weighted return is an important metric because it shows the true rate of growth. If you calculate your return based only on your initial investment and most recent balance, you’re leaving out all the deposits and withdrawals you’ve made along the way—and that can result in a rate of return that doesn’t show the whole picture.

Who Uses Time-Weighted Return?

As accurate as the time-weighted return can be, it isn’t widely used by everyday investors. That may be due to its complexity, which we’ll touch on in a minute.

Instead, you’ll likely see fund managers calculating the time-weighted return for the portfolios they manage. Zeroing in on specific sub-periods can give them a better idea of how their management choices are affecting the fund’s performance.

How to Calculate Time-Weighted Return

To calculate the time-weighted return for a given sub-period, first:

  1. Subtract the starting balance from the ending balance
  2. Divide that result by the starting balance

You’ll need to do this calculation for every sub-period. You can then figure out the total time-weighted return by:

  1. Adding 1 to the result you got for each sub-period
  2. Multiplying each of the totals together
  3. Subtracting 1 from the result

Confused yet? Seeing an example can help bring things into focus. Let’s say you invest $5,000 in an exchange-traded fund (ETF). After six months, the value grows to $5,500. Here’s the time-weighted return for this sub-period:

Sub-period #1: $5,500 – $5,000 / $5,000 = 0.10 (or 10%)

Let’s say you invest another $5,000, kick-starting a new sub-period. After three months, the value grows to $11,500. The time-weighted return for this sub-period is:

Sub-period #2: $11,500 – $10,500 / $10,500 = 0.095 (or 9.5%)

Now let’s say there’s talk of a recession and you’re worried about a potential dip in the stock market. You decide to pull out $1,500. Three months later, the fund’s value is $9,000. The time-weighted return for this sub-period is:

Sub-period #3: $9,000 – $10,000 / $10,000 = -0.10 (or -10%)

Now let’s put it all together:

Total time-weighted return = (1 + 0.10) x (1 + 0.095) x (1 + -0.10) – 1 = 0.084 (or 8.4%)

Your total time-weighted return for the past 12 months is 8.4%.

What’s the Difference Between Time-Weighted Return and Rate of Return?

Your actual return can be impacted by the money moving into and out of your portfolio. The time-weighted return accounts for these changes—but the regular rate of return does not. In this way, the latter is limited because it doesn’t consider deposits and withdrawals.

Below is the formula to calculate the regular rate of return:

[ (current value – initial value) / initial value ] x 100

Let’s go back to the 12-month example above. The regular rate of return would be:

[ ($9,000 – $5,000) / $5,000 ] x 100 = 80%

In this case, the time-weighted return and the regular rate of return show two different measurements of the same fund. That’s not to say the regular rate of return doesn’t matter—it can still help you see how far forward (or backward) you’ve come.

The Bottom Line

A portfolio’s time-weighted return can be a helpful metric because it provides a more nuanced idea of how your money is doing—even if the calculation is a little confusing. Whether you choose to do the math is up to you, though it’s more commonly used by fund managers looking to track a portfolio’s performance. As an individual investor, calculating the regular rate of return may be quicker and easier.

The post What Is Time-Weighted Return? appeared first on Experian’s Official Credit Advice Blog.

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