Time-weighted return

Definition

Time-weighted return is a method of calculating the performance of an investment portfolio that measures the compound rate of growth of one unit of currency invested in the portfolio over a specified time period. This approach eliminates the effects of cash flows into or out of the investment, allowing for a more accurate comparison of an investment's performance over time and across different portfolios.

5 Must Know Facts For Your Next Test

1. The time-weighted return method is particularly useful for evaluating the performance of fund managers since it removes the impact of any external cash flows caused by investor decisions.
2. This method divides the investment period into sub-periods based on when cash flows occur, calculating returns for each sub-period before compounding them.
3. In practice, time-weighted return is often used by institutional investors to assess performance over time, making it a standard benchmark in financial reporting.
4. Unlike money-weighted returns, which consider the timing and size of cash flows, time-weighted returns provide a clearer picture of an investment's true performance.
5. The formula for calculating time-weighted return involves multiplying the growth factors for each sub-period and then subtracting one to express the result as a percentage.

Review Questions

• How does time-weighted return differ from other performance metrics like money-weighted return?
  • Time-weighted return focuses solely on the investment's performance by removing the effects of cash flows into and out of the portfolio, while money-weighted return accounts for these cash flows, reflecting their impact on overall returns. This makes time-weighted return particularly valuable for assessing a fund manager's effectiveness, as it provides a more accurate representation of how well an investment performs independent of investor behavior.
• Discuss why time-weighted return is favored by institutional investors when evaluating portfolio performance.
  • Institutional investors favor time-weighted return because it allows for consistent comparisons across different investment portfolios without being influenced by external cash flows. By using this method, they can accurately assess how well their investments have performed over specific periods, which helps in making informed decisions about future investments. Additionally, it provides a standard metric that aligns with industry benchmarks, facilitating clearer communication among stakeholders.
• Evaluate the significance of calculating time-weighted return in real estate investments compared to traditional financial assets.
  • Calculating time-weighted return in real estate investments is significant because it allows investors to isolate the performance of their property investments from fluctuations caused by external factors such as market entry and exit timings. Unlike traditional financial assets, real estate often involves substantial cash flows due to purchases or sales at various points in time. By applying a time-weighted approach, real estate investors can better understand their true investment performance and make more strategic decisions regarding property management and future acquisitions.

Related terms

cash flow: Cash flow refers to the total amount of money being transferred in and out of an investment, which can impact the overall return if not properly accounted for.

internal rate of return (IRR): IRR is a metric used to estimate the profitability of potential investments, representing the annual rate of growth an investment is expected to generate, factoring in cash flows.

holding period return: Holding period return is the total return received from holding an asset or portfolio over a specific time period, including both capital appreciation and income.