What is the time-weighted rate of return?
Impact of Capital Inflows and Outflows on Investment Returns
During an investment period, accounts experience both capital inflows (e.g., external cash deposits and security purchases) and capital outflows (e.g., withdrawals and security sales). The timing and size of these movements can significantly affect the rate of return, sometimes leading to distorted performance metrics.
How Capital Flows Can Skew Returns
Imagine an account reporting a 7% return at the end of an investment period. If 3% of that return is due to a last-minute cash inflow, then the reported figure does not accurately reflect investment performance. This inflow inflates the return, creating a misleading impression of growth.
Breaking the Investment Period into Sub-Periods
To provide a clearer picture, Totality divides an investment period into sub-periods, ensuring each inflow or outflow is factored in at the time it occurs.
- Each sub-period reflects a capital movement and its effect on returns.
- Totality further refines this by breaking sub-periods into trading days, where capital flows are grouped by daily movements rather than the entire investment timeframe.
Time-Weighted Rate of Return (TWRR) Calculation
To accurately measure returns, two key factors are considered:
Time: The specific sub-period when the capital flow occurred.
Size: The actual amount of capital moved in the transaction.
This TWRR method eliminates distortions caused by sudden cash movements, providing investors with a more precise view of their portfolio performance
Take total control of your portfolio, today.
