Time-Weighted Rate of Return (TWR)
Candlefocus EditorThe Time-weighted Rate of Return (TWR) is usually expressed as a percentage and tells investors about the performance of the portfolio in absolute rather than relative terms. TWR is a better measure than the Return on Investment (ROI) because it is not affected by the timing and amount of cash flows into and out of the portfolio and therefore can accurately reflect the true performance of the portfolio.
TWR is calculated by multiplying the rate of return of each sub-period together or using a 'geometric method' that ‘links’ the returns of each sub-period together to give an overall rate of return over the entire period.
The geometric linking method, an extension of the TWR calculation, is a technique which accounts for the effect of compounding over time. Rather than just multiplying the rate of return for each period together, this method takes into account the fact that the return from the previous period is reinvested and also makes a return.
Time-weighted Rate of Return is arguably the most important measure of investment performance because it is free from the effects of cash flows, which can have a large impact on other investment performance measures such as Return on Investment (ROI). TWR therefore provides an accurate picture of the true performance of the investment and can be used to compare and evaluate portfolios over different time periods.
Ultimately, Time-weighted Rate of Return is an important tool for investors to gauge the performance of a portfolio or fund over a given period of time. By tracking the TWR of a portfolio over time, investors can identify potential problems and opportunities in their investments and make informed decisions.