When you invest, it’s important to periodically review your portfolio’s performance by looking at your return. A return is the gain or loss for an investment or portfolio. It can be shown as a dollar amount or as a percentage.
There are a number of different ways to measure portfolio returns, and there are different reasons why you might choose one calculation over another. With our Smart Portfolios1, we use something called a time-weighted return (TWR). It’s a standard industry calculation that essentially measures the return on your investments, and removes considerations of any additions or subtractions of capital.
Time-weighted return defined
Time-weighted return is a commonly-used calculation when someone else is managing your portfolio for you, because it removes the impact of any deposits or withdrawals that you may make, but which they cannot control. For example, Stash cannot control when you deposit money into, or withdraw money, your Smart Portfolio.
Although it may sound complicated, TWR really measures how well Stash is managing your money, and how your Smart Portfolio is performing.1 Returns calculated using other methodologies, which can include your deposits or withdrawals, easily become distorted, and can give you an inaccurate picture of your portfolio’s performance.
For example, another calculation called a simple return takes into consideration the timing of your cash flow into or out of your portfolio, and it measures the actual dollar amount earned on your portfolio, indicating the change in the total investment value. This is a factual calculation, but it may not properly reflect the portfolio manager’s investment strategy.
Time-weighted return in action
Take a look at the following example, where we have two fictional investors who deposit money in different months, into the same hypothetical portfolio. The impact of the cash flow is removed from the weighted return calculation, so the monthly time-weighted return experience is the same regardless of whether someone deposited money.
*Remember all investors are different, and you must take into account your own financial situation and goals when investing. All investing involves risk, and it’s possible to lose money in the market. The Hypothetical below is purely for illustrative purposes and does not represent the actual performance of any client nor does it reflect the performance of any of the underlying investments therin.
This hypothetical does not account for fees or taxes. It is for illustrative purposes only and is not indicative of any actual investment. Actual return and principal value may be more or less than the original investment. Investing Involves Risk, including the loss of principal.
Positive time-weighted return and negative dollar value
Investor A and Investor B both start out by investing $100 in the portfolio, which has a +20% return in January, followed by a -10% return, or loss, in February.
In January, Investor B makes a $100 deposit into the account right before the market upswing, while Investor A does not. Since Investor A’s holdings are smaller, his or her gain would be $20 in January. In comparison, Investor B invests more money, and gains $40 that month.
In February, let’s say Investor A makes a $100 deposit into the account, while Investor B does not. The opposite happens here: Investor A buys right before the market dips, resulting in a $22 loss, and a $24 dollar loss for Investor B.
While both investors have an 8% gain for the two months, Investor A loses $2, while Investor B makes $16. That’s because Investor A contributes to the market right before a market dip, while Investor B contributes right before the upswing. Investor A’s poor timing has an impact on the actual dollars earned (or lost in this example), while the portfolio’s investments actually have a positive return during the same time period.
Our investing philosophy
We recommend following the principles of the Stash Way when you’re investing: Think long-term, invest regularly, and diversify. By investing regularly, investors will sometimes put money into the market when prices are higher, and at other times when they’re lower. Over time, you’re likely to get a better price-buying experience.
Remember though, all investing involves risk, and you can always lose money in the market.