Key Takeaways
- Measures investor's actual return including cash flow timing.
- Calculates internal rate of return (IRR) on all cash flows.
- Weights returns by portfolio size over time.
- Reflects personal investment performance, unlike time-weighted return.
What is Money-Weighted Rate of Return?
The Money-Weighted Rate of Return (MWRR) is the internal rate of return (IRR) of an investment portfolio that accounts for the timing and size of cash flows such as contributions and withdrawals. It represents the discount rate making the net present value (NPV) of all cash flows equal to zero, reflecting your personal investment performance over time.
Unlike other metrics, MWRR incorporates your actual deposit and withdrawal decisions, providing a tailored view of your returns. This makes it a practical alternative to the internal accounting rate of return concept often used in project evaluations.
Key Characteristics
MWRR has distinct features that differentiate it from other return measures.
- Time value of money: It factors in how the value of money changes over time, similar to the principle behind Macaulay duration.
- Cash flow sensitivity: MWRR weights returns based on when and how much you invest or withdraw, reflecting your actual investment experience.
- Personalized measure: It emphasizes the impact of your timing decisions, unlike time-weighted returns which isolate manager performance.
- Computational method: Calculated by solving for the IRR that sets the NPV of cash flows to zero, often using spreadsheet functions.
How It Works
To calculate MWRR, you list all cash flows including initial investments, subsequent contributions, withdrawals, dividends, and final portfolio value. Then, you solve for the discount rate that zeroes out the net present value of these cash flows.
This process accounts for the opportunity cost of money, effectively capturing how your investment timing affects returns. Many investors apply this method to measure the real growth of portfolios that include irregular cash movements, making it especially relevant for tactical asset allocation decisions.
Examples and Use Cases
MWRR is widely used to assess individual portfolio performance where cash flow timing matters.
- Exchange-traded funds: Investors tracking returns on ETFs like IVV or SPY can use MWRR to evaluate their personal gains considering deposits and withdrawals.
- Dividend reinvestment: When dividends are reinvested, as with many dividend stocks, MWRR captures the effect of those cash inflows on your overall return.
- Portfolio management: Platforms offering best ETFs guides often incorporate MWRR to help you understand how your cash flow timing affects performance.
Important Considerations
While MWRR provides a personalized return measure, it is sensitive to the timing and magnitude of your cash flows, which can sometimes misrepresent manager skill or market performance.
Therefore, it is advisable to complement MWRR with other metrics like time-weighted return when comparing fund managers or evaluating pure investment performance. Using spreadsheet IRR functions can simplify MWRR calculations, but ensure consistent period definitions to accurately annualize results.
Final Words
Money-Weighted Rate of Return captures your personal investment experience by accounting for the timing and size of your cash flows. To see how your investment decisions impact your returns, calculate your MWRR regularly and compare it against benchmark rates or alternative investments.
Frequently Asked Questions
Money-Weighted Rate of Return (MWRR) is the internal rate of return (IRR) of an investment portfolio that accounts for the size and timing of cash flows, including contributions, withdrawals, and the final value. It reflects an investor's actual experience by weighting performance more heavily during periods when the portfolio is largest.
MWRR considers the timing and amount of cash flows, making it a personalized measure of investment performance influenced by an investor's decisions. In contrast, Time-Weighted Rate of Return (TWRR) removes the impact of cash flows to measure the pure performance of the investment itself, which is ideal for comparing fund managers.
The timing of cash flows is crucial because MWRR accounts for when money is invested or withdrawn, reflecting the time value of money. This means investments made when the portfolio is larger have a greater impact on the overall return, giving a more accurate picture of an investor’s real returns.
MWRR is calculated by finding the discount rate that makes the net present value (NPV) of all cash flows equal to zero. This is typically done using financial software or spreadsheet functions like Excel’s IRR or MIRR, which solve for the rate in the equation summing cash flows discounted to present value.
Yes, MWRR includes all cash flows such as dividends, additional contributions, withdrawals, and the final sale value. This comprehensive approach ensures the return measures the actual performance experienced by the investor.
MWRR is especially useful for individual investors who want to understand the impact of their personal investment timing and cash flow decisions. However, it may be less appropriate for evaluating fund manager performance, where Time-Weighted Rate of Return is preferred.
One limitation of MWRR is that it can be heavily influenced by the timing of cash flows, which might not accurately reflect the underlying investment's performance. This means poor timing decisions can distort the perceived return, making comparisons between investors less straightforward.
Yes, MWRR can be expressed as a cumulative return over the entire period or annualized to show an average yearly return. Annualizing is often done using spreadsheet functions like Excel’s IRR or MIRR, which adjust the return for the length of the investment period.
