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When evaluating performance, there are several factors that can impact your returns:
Inflows
Contributions
(i.e., Pre-Authorized Contributions or lump sum deposits)
Outflows
Withdrawals
(i.e., Automatic Withdrawal Plans or lump sum withdrawals)
Changes in market value
Changes in the value of your investments, including mutual funds
(i.e., appreciation or depreciation)
There are two commonly used ways to evaluate performance: time-weighted rate of return (TWRR) and money-weighted rate of return (MWRR).
The time-weighted method is the most commonly used method to calculate investment returns, including the performance of an index or mutual fund. It only looks at the compounded rate of return of a portfolio over time and does not factor in the impact of your cash flows (contributions/withdrawals).
This rate of return is suitable for comparing the performance of different funds; however, using this method to evaluate the return for your specific investment portfolio can have its limitations. In some cases, your trading activity can significantly impact your portfolio's overall return. For instance, contributing before an investment goes up in value can enhance your personal rate of return, while withdrawing after a decline can diminish returns when selling at a lower price, particularly if there’s a subsequent recovery.
The money-weighted method on the other hand, incorporates cash flow decisions in the performance calculation and is unique to you. It accounts for your contributions and/or withdrawals, as well as distributions such as dividends and interest income, to provide a more personalized measure of your portfolio’s performance. This is why the money-weighted rate of return– otherwise known as the personal rate of return – is shown on your investment statement.
Which rate of return should I use?
Both the TWRR and MWRR provide important, but different, measures of investment performance. The time-weighted method is suitable for isolating and measuring the performance of a specific investment, while the money-weighted method is best used to measure overall personal portfolio performance and track progress towards your investment goals.
Consider the following hypothetical example of three investors who all start with $10,000 in their portfolio but make varying investing decisions.
Between their initial investment and the end of the first year, the fund declines 8%. In the second year, the fund appreciates by 12%.
For illustrative purposes only. All contributions and withdrawals are assumed to have taken place at the beginning of the second year.
| Investor | Year | Beginning Value | Contributions | Withdrawals | Fund Performance | Ending Value | Change in Value | Investor Action |
|---|---|---|---|---|---|---|---|---|
| Vanessa | 1 | $10,000 | - | - | -8% | $9,200 | -$800 | Contributed $8,500 |
| 2 | $9,200 | $8,500 | - | 12% | $19,824 | $2,124 | ||
| Tom | 1 | $10,000 | - | - | -8% | $9,200 | -$800 | Withdrew $8,500 |
| 2 | $9,200 | - | $8,500 | 12% | $784 | $84 | ||
| Jessica | 1 | $10,000 | - | - | -8% | $9,200 | -$800 | No action taken |
| 2 | $9,200 | - | - | 12% | $10,304 | $1,104 |
Time-weighted rate of return method
Since Vanessa, Tom, and Jessica held the same investment over the same period, their time-weighted rate of return is the same, because only the fund performance was considered.
Vanessa, Tom, & Jessica’s time-weighted return = 1.51%
Money-weighted rate of return method
While all three investors have the same time-weighted return, their cash flow decisions led to varying money-weighted rates of return because the impact of their contributions and withdrawals was also considered.
Vanessa’s cash flow decision positively impacted her portfolio’s performance, by contributing $8,500 at the start of the second year just before the fund performed well.
Vanessa’s money-weighted return = 4.58%
Tom’s cash flow decision negatively impacted his portfolio’s performance, by withdrawing $8,500 at the start of the second year after the fund performed poorly. Selling his investments hindered his ability to recover his losses when the fund eventually rebounded.
Tom’s money-weighted return = - 6.59%
Jessica did not make any contributions or withdrawals, so her decisions did not impact her portfolio’s performance. As a result, both her time-weighted return and money-weighted returns are the same.
Jessica’s money-weighted return = 1.51%
The bottom line: Reviewing your portfolio’s performance with your Scotiabank advisor can help you make informed decisions about your money. Remember that long-term investments require a long-term view on performance. This can help you see beyond short-term return performance fluctuations to the bigger picture for a more accurate representation of how you are tracking towards your goals.
This document has been prepared by Scotia Global Asset Management and is provided for information purposes only.
The information provided is not intended to be investment advice. Investors should consult their own professional advisor for specific investment and/or tax advice tailored to their needs when planning to implement an investment strategy to ensure that individual circumstances are considered properly and action is taken based on the latest available information.
