Time-Weighted Rate of Return (TWR)

What it is

The time-weighted rate of return (TWR) measures a portfolio’s compound growth rate while eliminating the effect of external cash flows (deposits and withdrawals). By dividing the total period into sub-periods between cash flows, computing each sub-period’s return, and linking them geometrically, TWR isolates the investment performance driven by the manager or strategy.

Why it matters

• Removes the timing and size effect of investor cash flows, allowing apples‑to‑apples comparisons between funds or managers.
• Useful for benchmarking a portfolio against indexes or other strategies.
• Reflects compound performance over time, making it suitable for performance attribution and forecasting growth under the strategy’s returns.
• Not appropriate for measuring an individual investor’s realized dollar return—use a money‑weighted return (internal rate of return) for that purpose.

How to calculate TWR

1. Identify sub-periods: split the overall period at each external cash flow (each deposit or withdrawal).
2. For each sub-period, compute the return (HP):
   HP = (End Value − (Initial Value + Cash Flow)) / (Initial Value + Cash Flow)
3. “Cash Flow” here is the net external flow that occurs at the end of the sub-period (positive for inflow, negative for outflow).
4. Link sub-period returns geometrically:
   TWR = [(1 + HP1) × (1 + HP2) × … × (1 + HPn)] − 1

Example

Two funds start the year with $1,000,000 each. Cash flows occur only after quarter closes; sub-period returns are computed before those flows.

Fund A
* Q1: rises to $1,200,000 (20%); then +$400,000 → total $1,600,000
HP1 = 0.20 → factor 1.20
* Q2: starts $1,600,000 → rises to $1,650,000 (3.125%); then −$200,000 → total $1,450,000
HP2 ≈ 0.03125 → factor 1.03125
* Q3: starts $1,450,000 → rises to $1,500,000 (≈3.448%); then +$200,000 → total $1,700,000
HP3 ≈ 0.03448 → factor 1.03448
* Q4: starts $1,700,000 → rises to $1,900,000 (≈11.765%); then +$300,000 → year‑end $1,900,000
HP4 ≈ 0.11765 → factor 1.11765

TWR_A = (1.20 × 1.03125 × 1.03448 × 1.11765) − 1 ≈ 42.9%

Fund B
* Q1: rises to $1,150,000 (15%); then +$50,000 → total $1,200,000
HP1 = 0.15 → factor 1.15
* Q2: starts $1,200,000 → rises to $1,400,000 (≈16.667%); then +$50,000 → total $1,450,000
HP2 ≈ 0.16667 → factor 1.16667
* Q3: starts $1,450,000 → rises to $1,600,000 (≈10.345%); then −$100,000 → total $1,500,000
HP3 ≈ 0.10345 → factor 1.10345
* Q4: starts $1,500,000 → rises to $1,800,000 (20%); then +$50,000 → year‑end $1,850,000
HP4 = 0.20 → factor 1.20

TWR_B = (1.15 × 1.16667 × 1.10345 × 1.20) − 1 ≈ 77.6%

Even though Fund A ends with a slightly higher absolute assets under management than Fund B in some scenarios, TWR shows Fund B delivered stronger investment performance after removing the effects of differing cash flow patterns.

When to use TWR

• Evaluating professional fund managers or advisors whose performance you want isolated from investor cash flows.
• Comparing strategies and funds with different cash‑flow profiles.
• Performance reporting for pooled or institutional accounts where manager decisions—not investor timing—are being judged.

Limitations

• Does not indicate the investor’s actual dollar return—money‑weighted measures (IRR) are better for that.
• Requires precise sub‑period valuation at each cash flow; inaccuracies in timing or valuation can distort results.
• Can be more cumbersome to compute for frequent or irregular cash flows without automation.

Bottom line

The time‑weighted rate of return is the standard method for assessing and comparing investment performance while neutralizing the impact of external cash flows. Use TWR to evaluate manager skill and benchmark strategy returns; use money‑weighted returns to understand an individual investor’s realized return.