Time-weighted return

RELATED WIKI ARTICLES
 
TOP CONTRIBUTORS

Time-weighted returns is a measure of the compound rate of return of a portfolio over a stated period of time. It requires a set of sub-period returns to be calculated whenever there is an external cash flow, such as a deposit or withdrawal from the portfolio. In essence, it calculates the geometric total and mean return as opposed to the arithmetic total and mean return. This method does not include or have any distortions created when money is deposited or withdrawn from a portfolio. This is in contrast to Money-weighted returns. In order for firms to meet Global Investment Performance Standards, they must use time-weighted returns as opposed to money-weighted returns.

Assumptions of Time-weighted returns

Time-weighted returns assume that all cash distributions (i.e. dividends, interest, etc) are reinvested back into the portfolio. It also eliminates the effect of cash flows in and out of the portfolio, in essence treating the portfolio as if there were a single investment at the beginning of the measurement period.

How are Time-weighted returns calculated?

A quick example would help illustrate the point. Assume your portfolio's value was $1,000 at the beginning of the month, and $1900 at the end of the month. On the 10th day of the month, you deposit $250, and on the 20th day of the month you deposit another $250. The overall value of your portfolio (after the deposits are made) on the 10th day is $1,300, and $1,700 on the 20th day. Therefore, there are three "sub-periods"- the first includes days 1-10, the second days 11-20, and finally the third is for days 21-30.

In order to calculate the time weighted return, we first need to calculate the return of each subperiod.

  • The return of subperiod one is: [ ($1,300-$250)-$1,000 ] / $1,000 = 5%.
  • The return of subperiod two is: [ ($1,700-$250)-$1,300 ] / $1,300 = 11.5%
  • The return of subperiod three is: [ ($1,900-$1,700) ] / $1,700 = 11.8%

Finally, we compound the returns together to calculate the overall time-weighted rate of return:

  • Time-weighted rate of return: [(1+0.05)*(1+0.115)*(1+0.118)]^0.33 -1 = 9.39%

Differences between time-weighted and money-weighted returns

The main difference between time weighted and money weighted returns is that time weighted returns ignores the effect of cash inflows/outflows, whereas money-weighted returns incorporate the size and timing of cash flows. The money-weighted rate of return internalizes both the timing and size of external cash flows (such as deposits and withdrawals), whereas time-weighted return correct for this by allowing different "subperiods" to have different returns.

Wikinvest © 2006, 2007, 2008, 2009, 2010, 2011, 2012. Use of this site is subject to express Terms of Service, Privacy Policy, and Disclaimer. By continuing past this page, you agree to abide by these terms. Any information provided by Wikinvest, including but not limited to company data, competitors, business analysis, market share, sales revenues and other operating metrics, earnings call analysis, conference call transcripts, industry information, or price targets should not be construed as research, trading tips or recommendations, or investment advice and is provided with no warrants as to its accuracy. Stock market data, including US and International equity symbols, stock quotes, share prices, earnings ratios, and other fundamental data is provided by data partners. Stock market quotes delayed at least 15 minutes for NASDAQ, 20 mins for NYSE and AMEX. Market data by Xignite. See data providers for more details. Company names, products, services and branding cited herein may be trademarks or registered trademarks of their respective owners. The use of trademarks or service marks of another is not a representation that the other is affiliated with, sponsors, is sponsored by, endorses, or is endorsed by Wikinvest.
Powered by MediaWiki