On your dashboard, you will see 3 different kinds of returns: simple, time weighted, and money weighted returns. Below is an explanation of each.
A. Simple Returns
- Simple returns are total earnings in your portfolio divided by net deposits.
- Simple Return = Earnings ÷ Net Deposits
- Net deposits = Deposits – Withdrawals
For example: If you have deposited $10,000, and your portfolio grew by $500, the simple return of your portfolio is 5%. I.e: $500 / $10,000 = 5% simple rate of return.
Limitations of the simple returns calculation:
- It does not accurately reflect the full picture of your investment history. This is because it does not factor in the time period of your initial investment nor any subsequent deposits.
For example, suppose you had invested $10,000 on January 1st, and at the end of the year you saw that your portfolio was worth $10,500. You can accurately say that you have made 5% return during this calendar year. However, if you had deposited an additional $7,000 shortly before the end of the year and calculated the simple return, you would see that the return was 2.94%. Simple return = Earnings ÷ Net Deposits = $500 ÷ $17,000 = 0.0294 2.94%
- If you decide to withdraw the entire amount, hopefully not because you are reacting to market fluctuations, your simple return will be negative.
Let’s say you had the following in your account:
- Deposits = $10,000
- Earnings = $2,000
- Simple return = Earnings ÷ Net Deposits = 2,000 ÷ 10,000 = 0.2= 20%
Now let’s assume you wish to withdraw your funds:
- Deposit = $10,000
- Earnings - $2,000
- Net deposits = deposits – withdrawals = $10,000 – $12,000 = -$2,000
- Simple return = Earnings ÷ Net Deposits = 2,000 ÷ -2,000 = -1 or -100%
Your simple returns on your dashboard now appear as negative, even though in reality you have earned $2,000! We know this could be confusing, but in the spirit of transparency, we are keeping all the numbers at your disposal.
B. Time Weighted Returns (TWR)
Time Weighted returns measure the performance of an investment portfolio by taking a single investment contribution and measuring its growth and loss at the end of a specific time period.
It does not take into consideration the effects of deposits or withdrawals on the account. This is because it only reflects the impact of the market and your investment selections. In other words, the TWR is designed to compensate for however many deposits and withdrawals you make to your account. The TWR method looks at if and when a deposit or withdrawal occurred, and then breaks down a portfolio’s overall return into corresponding sub-periods.
To calculate the Time Weighted Returns, you would proceed in the following manner:
TWR Formula = [(1 + HP1) x (1 + HP2) x ... x ( 1 + HPn)] – 1
- TWR = Time-Weighted Return
- n = Number of Periods
- HP = (End Value – Initial Value + Cashflow)/(Initial Value + Cashflow) HP^n = Return for Period “n”
Limitation of Time Weighted Return: Though this method of calculating returns is considered the industry standard for Investment Managers, using TWR is a very complex way to track and calculate cashflow. Money moving in and out of portfolios frequently can skew the calculation of your return.
C. Money Weighted Returns (MWRR)
A money-weighted rate of return (MWRR) is designed to measure your specific investment experience – it will show you exactly how your investment account performed, taking all factors impacting it into account. In contrast to a time-weighted rate of return calculation, your deposits, withdrawals and transfers do affect the account’s money weighted rate of return. The money-weighted rate of return (MWRR) calculates the performance of an investment that accounts for the size and timing of deposits or withdrawals.
It considers two elements of your Sarwa portfolio:
- Cash inflows of Dividends, Capital Gains, and Deposits
- Cash outflows of Reinvested Dividends, Investment Fees (Sarwa Management Fee), and Withdrawals
The math/formula is quite complicated in this case, but for reference it is the following: PVO = PVI = CF0 + CF1 / (1+IRR) + CF2 / (1+IRR)2 + CF3 / (1+IRR)3 + ......etc.
If you want to judge the overall performance of an investment including both investment returns, fees, and timing of cashflows (in and out), then you should use a money-weighted return.