Modified Dietz Method

What it is

The Modified Dietz method is a dollar-weighted way to measure a portfolio’s historical rate of return over a specified period while accounting for the timing of external cash flows (contributions, withdrawals, fees). It assumes a single, constant rate of return for the period and uses weighted cash flows so that each flow is included only for the portion of the period it was invested.

Why it’s used

• More accurate than the simple Dietz method, which assumes all cash flows occur mid-period.
• Widely used by investment managers for client reporting and performance attribution.
• Simpler to compute than solving an internal rate of return (IRR), yet it reflects the impact of cash flow timing.
• Recommended in many reporting frameworks as a practical compromise between simplicity and accuracy.

Formula and terms

Return (R) is calculated as:

R = (EMV − BMV − ΣCF) / (BMV + Σ(wi × CFi))

Where:
* BMV = beginning market value
* EMV = ending market value
* CFi = each external cash flow (positive for contributions, negative for withdrawals)
* wi = weight for each cash flow = fraction of the period remaining after the flow (i.e., time the cash stayed invested divided by total period length)
* Σ denotes summation over all cash flows during the period

Weights: if the period length is D days and a cash flow occurs d days after the start, wi = (D − d) / D.

Example

Period: 90 days
BMV = $100,000
EMV = $110,000
One contribution of $10,000 made on day 30 (d = 30)

Weight for the contribution: w = (90 − 30) / 90 = 60/90 = 0.6667
Numerator = 110,000 − 100,000 − 10,000 = 0
Denominator = 100,000 + (0.6667 × 10,000) = 106,666.67
Return R = 0 / 106,666.67 = 0%

This shows how timing can neutralize or amplify measured returns depending on when cash is added or removed.

Advantages

• Reflects the dollar impact of cash flow timing without solving for an IRR.
• Straightforward to implement in spreadsheets and reporting systems.
• Useful for performance attribution where linking returns to flows matters.
• Appropriate for measuring an individual or manager’s realized rate of return over a period.

Limitations

• Assumes a constant rate of return across the period — can be misleading in volatile markets or when returns are non-linear.
• Accuracy declines with many intra-period cash flows unless weights are applied precisely.
• Not a true time-weighted return; it incorporates the effect of investor cash flows, so it measures the investor’s experience rather than manager skill alone.
• The term “modified internal rate of return” is sometimes used informally for the result, but this is different from the MIRR used in capital-budgeting, which adjusts reinvestment assumptions.

When to use it

• For client reporting when cash flows materially affect performance and you want a straightforward, dollar-weighted measure.
• When performance attribution requires linking flows to returns but full time-weighted daily linking is impractical.
• Less suitable when the objective is to isolate manager performance independent of investor cash flows — in those cases a time-weighted return is preferred.

Key takeaways

• The Modified Dietz method weights cash flows by the portion of the period they were invested, producing a practical dollar-weighted return.
• It balances simplicity and accuracy, making it common in investment reporting and performance attribution.
• Be aware of its assumption of a constant rate and potential distortions during volatile periods or with many cash flows.