Measuring Portfolio Return 📈💰
When measuring the return of a single stock, the math is easy. But for a portfolio where you might add or withdraw money at different times, the math becomes tricky. We use two main methods.
1. Money-Weighted Rate of Return (MWRR)
The MWRR is essentially the Internal Rate of Return (IRR) of the portfolio.
- Logic: It measures the performance of the money invested.
- Influenced by: It is heavily influenced by the Timing and Size of cash flows.
- Use Case: It is used to evaluate an individual investor whose decisions to add or withdraw money affect the results.
2. Time-Weighted Rate of Return (TWRR)
The TWRR breaks the time period into sub-periods (whenever a cash flow occurs) and measures the daily/monthly growth.
- Logic: It eliminates the effect of cash inflows and outflows.
- Influenced by: Only the performance of the stocks themselves.
- Use Case: It is the global standard for evaluating portfolio managers (like mutual fund managers), because we shouldn't punish or reward a manager for the investor's decision to deposit or withdraw money.
Important
If you put money into a fund just before it jumps 50%, your MWRR will be much higher than the fund's TWRR. This is because you timed your entry perfectly!
3. Which one is better?
- If you are a Bank/Fund Manager, use TWRR to show you are a good picker.
- If you are an Individual Investor, use MWRR to see how much money you actually made on your total savings.
Summary
- MWRR measures dollar-weighted performance (IRR).
- TWRR measures pure asset performance (Geometric mean).
- Professional fund managers always report TWRR.
- Cash flows (deposits/withdrawals) are the reason why these two numbers are different.
Quiz Time! 🎯
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