Money-Weighted Return vs Time-Weighted Return. What is the difference?

Money-Weighted Return (MWR) and Time-Weighted Return (TWR) are two different method of calculating a portfolio performance. The key difference between them lies in the way cash flows are factored in.

Time-Weighted Rates of Return focus purely on the performance of the investment, without considering the impact of cash flows into, or out of, the portfolio.

Money-Weighted Rates of Return factor in the size and timing of your investments and withdrawals, giving you a personalized understanding of your portfolio's performance. 

What is Time-Weighted Return?

The Time Weighted Return (TWR) is a method that measures the compound growth rate of your investment portfolio over a specific period. The unique aspect about TWR is that it does not take into account the impact of cash flows into and out of the portfolio.

Time Weighted Return is ideal for gauging the performance of broad market indices or understanding the impact a fund manager has on the performance of an investment. It focuses purely on the growth of the portfolio, unaffected by any additional investments or withdrawals you may make.

What is Money-Weighted Return?

The Money Weighted Return (MWR) is a method of calculating the rate of return on an investment portfolio, which considers both the amount of money invested and the timing of those investments. It reflects the personal return of the investor because it takes into account the individual's specific cash flows.

If an investor puts more money in an investment at a time when the investment's value is high, it will significantly affect the money-weighted rate of return as we'll see in the example below.

Cash flows can include cash contributions or withdrawals, dividends received or reinvested (DRIP), proceeds from sold positions and interest.

Example: Time-Weighted vs Money-Weighted Return

Consider the difference between money-weighted and time-weighted returns with an example of an investor buying and selling a stock as follows:

DateTransactionSharesShare PriceOperation
January 1stBuys 10 shares10$10invested $100
April 1stSells 5 shares5$15withdrew $75
July 1stBuys 5 shares5$20invested $100
October 1stSells all 10 shares10$12withdrew $120

To calculate the Time-Weighted Return, we simply calculate the compound growth rate of the stock price over the entire period, without considering cash flows.

For each period:

  • January 1st to April 1st: (15-10)/10 = 50%
  • April 1st to July 1st: (20-15)/15 = 33.33%
  • July 1st to October 1st: (12-20)/20 = -40%

TWR = (1 + 50%) \* (1 + 33.33%) \* (1 - 40%) = 1.20

The Time-Weighted Return is 20.00% (Annualized is 27.60%)

However, you can notice the investor bought for $200 ($100+$100), and sold his entire position for $195 ($75+$120). Therefore, he lost $5 so his real return is actually negative.

This is because even though the stock went up during his whole investing period, he had more money invested during the short period of time when the stock went down from $20 to $12.

When to use Money-Weighted Return vs Time-Weighted Return?

Time-weighted return is suitable for gauging a fund manager's performance or contrasting a portfolio to market indexes. It's not affected by deposit and withdrawal size and timing, resulting in a pure reflection of stable growth. This factor makes it useful for comparing different funds or portfolios by removing individual investment timing effects.

Money-weighted return is a measure of investment performance that considers both the magnitude and timing of cash flows. It is perfect for calculating the actual financial return of your investments, including the effects of your decisions to invest more or withdraw from your portfolio.

This is why Beanvest uses the Money Weighted Return method for calculating your investment portfolio performance.

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