Financial Planning Wonk – Internal Rate of Return (IRR) v Time-Weighted Return (TWR)
October 31, 2012
Economy and Investing, Financial Planning
Your Client Private Page® currently has two types of returns displayed at the bottom of the Comparative Performance Review report. Here is how to differentiate between the two:
| Internal Rate of Return (IRR) | Time-Weighted Return (TWR) |
| This rate of return is also known as the “Dollar-Weighted” rate and it measures the performance of your portfolio based on how much is invested at any one time. For example, if you had a modest sum invested during the first month and then made a deposit that doubled the size of your account at the beginning of the second month, the second month’s return would carry twice as much weight as the first month’s in the calculation of your overall return. The IRR is more reflective of the actual dollar gains earned in your account. | The Time-Weighted Return is calculated as if there was a constant one-dollar investment in your account. In doing so, it ignores the effects of deposits and withdrawals that you may make. Unlike the IRR example to the left, the TWR would ignore the deposit made at the beginning of month two and give equal weight to the returns earned in each of the two months. |
| The Internal Rate of Return tells you how well you are personally doing. | The Time-Weighted Rate of Return tells you how well the overall investment strategy is doing. |