Why TWR? - very difficult to understd though this time-wt ret. esp if u Dca & wdraw some in betwn
It can be so difficult to determine how much money was earned on a portfolio when there are multiple deposits and withdrawals made over time. Investors can't simply subtract the beginning balance, after the initial deposit, from the ending balance since the ending balance reflects both the rate of return on the investments and any deposits or withdrawals during the time invested in the fund. In other words, deposits and withdrawals distort the value of the return on the portfolio.
The TWR provides the rate of return for each sub-period or interval that had cash flow changes.
Examples of Using the TWR
As noted, the time-weighted return eliminates the effects of portfolio cash flows on returns. To see this how it works, consider the following two investor scenarios:
Scenario 1 taken fr ivestopedia site
Investor 1 invests $1 million into Mutual Fund A on December 31. On August 15 of the following year, his portfolio is valued at $1,162,484. At that point (August 15), he adds $100,000 to Mutual Fund A, bringing the total value to $1,262,484.
By the end of the year, the portfolio has decreased in value to $1,192,328. The holding-period return for the first period, from December 31 to August 15, would be calculated as:
- Return = ($1,162,484 - $1,000,000) / $1,000,000 = 16.25% but .....
The holding-period return for the second period, from August 15 to December 31, would be calculated as:
- Return = ($1,192,328 - ($1,162,484 + $100,000)) / ($1,162,484 + $100,000) = -5.56%
The second sub-period is created following the $100,000 deposit so that the rate of return is calculated reflecting that deposit with its new starting balance of $1,262,484 or ($1,162,484 + $100,000).
The time-weighted return for the two time periods is calculated by multiplying each subperiod's rate of return by each other. The first period is the period leading up to the deposit, and the second period is after the $100,000 deposit.
- Time-weighted return = (1 + 16.25%) x (1 + (-5.56%)) - 1 = 9.79%
Difference Between TWR and ROR($-wt ret)
A
rate of return (ROR) is the net gain or loss on an investment over a specified time period, expressed as a percentage of the investment’s initial cost. Gains on investments are defined as income received plus any
capital gains realized on the sale of the investment.
However, the rate of return calculation does not account for the cash flow differences in the portfolio,
whereas the TWR accounts for all deposits and withdrawals in determining the rate of return.
This week finally green... my equity only $3k+. Ill observe how it moves this following months..