Time-Weighted Return (TWR) is a form of portfolio performance benchmarking that eliminates the cash flowing in & out of the portfolio to provide the actual performance for your investment.
It measures the performance seen in the time interval between deposits and withdrawals, and it avoids any distortions because it does not take into account the timing or amounts of deposits and withdrawals. (see below example for a more detailed explanation)
Why do we use TWR?
As an investor may top up different amounts at a different times, each additional top-up is invested for a different period of time. Using TWR eliminates the time distortion and looks at how each top-up contributes to the return of the portfolio in totality. By ruling out the time distortion, it allows you to accurately compare how well your portfolio is performing against other investments or benchmarks.
How TWR is calculated
To calculate time-weighted return, you can use the formula below.
TWR = [(1 + HP^1) x (1 + HP^2) x … x ( 1 + HP^n )] – 1
TWR = Time-Weighted Return
n = Number of Periods
HP = (End Value – Initial Value + Cashflow)/(Initial Value + Cashflow)
HP^n = Return for Period “n”
Other return calculation - Money Weighted Returns (Cumulative Returns)
Cumulative returns is the simple calculation of profit or loss against your net contribution.
If you have made only 1 investment and wish to determine your returns on the investments, Money Weighted Returns will be the easiest way to do it.
If you invest $10,000 and have $15,000 after a year, you can describe your Money Weighted Returns as 50%.
An illustration: Positive earning but negative time-weighted returns
Let’s say you invested $1,000 in Portfolio A on 1st January 2018. By 30 June 2018, your portfolio had lost 10% of its value, falling to $900. Then, you then make an additional deposit of $10,000. By 31 December 2018, your portfolio value increased by 5% to $11,445. ($10,900 x 1.05 = $11,445).
The final value of the portfolio at the end of 2018 would be $11,445, against inflows of $1,000 + $10,000 = $11,000.
The time weighted return will be (1-10%) x (1+5%) - 1 = -5.5%
The cumulative return will be $11,445-$11,000= $445
Time-Weighted Return is negative as the portfolio has decreased in value since the first contribution. While there is a positive dollar gain means that although your investments lost money in certain time period, your ending value is still greater from contributions.
The same applies to negative earning but positive time-weighted returns as it means that although your investments gained money in a certain time period, your ending value was lower from a withdrawal.
Read more about how we calculate investment returns here.