Time-Weighted Rate of Return (TWR)

The time-weighted rate of return (TWR) is a measure of the performance of an investment over a period of time, taking into account all cash flows, including dividends and interest. It is calculated by compounding the returns earned in each period, and then dividing the final value by the initial investment.

The TWR is a more accurate measure of investment performance than the simple arithmetic average of returns, because it takes into account the effects of compounding and cash flows. For example, if an investment earns a 10% return in the first year and a 20% return in the second year, the simple average return is 15%. However, the TWR is actually 18.18%, because the 20% return in the second year is compounded on top of the 10% return in the first year.

The TWR is also a more useful measure of investment performance than the internal rate of return (IRR), because the IRR does not take into account the timing of cash flows. For example, two investments with the same IRR could have very different TWRs, depending on when the cash flows are received.

The TWR is calculated using the following formula:

TWR = (Ending Value / Initial Value)^(1 / Number of Periods) - 1

Where:

• Ending Value is the value of the investment at the end of the period.
• Initial Value is the value of the investment at the beginning of the period.
• Number of Periods is the number of years in the period.

The TWR can be used to compare the performance of different investments, or to track the performance of a single investment over time. It is a useful tool for investors who want to make informed decisions about their investments.

Here are some additional points to keep in mind about the TWR:

• The TWR is a geometric average, which means that it is not affected by negative returns. This can make it a more useful measure of performance than the arithmetic average, which can be skewed by negative returns.
• The TWR is only a measure of past performance. It does not guarantee future returns.
• The TWR can be difficult to calculate for investments with multiple cash flows. In these cases, it may be necessary to use a financial calculator or software to calculate the TWR.

The time-weighted rate of return is a valuable tool for investors who want to measure the performance of their investments. It is a more accurate measure of performance than the simple arithmetic average of returns, and it takes into account the effects of compounding and cash flows. The TWR can be used to compare the performance of different investments, or to track the performance of a single investment over time.