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Time-Weighted Return vs. Internal Rate of Return PDF Print E-mail
Written by Larry Swedroe   
Thursday, 22 April 2010 00:00
Overview: This article defines time-weighted return (TWR) and internal rate of return (IRR) and discusses why each is the most appropriate measurement under differing circumstances.
Most investors are probably unaware that different types of return measures yield significantly different results for the same investment. After all, in theory, a return is a return is a return, right? Unfortunately, it is not quite that simple. Two common return measurements used by the investment industry are the TWR and the IRR.
 
Time-Weighted Return
TWR is the measurement required by the Global Investment Performance Standards published by the CFA Institute. Its distinguishing characteristic is that cash inflows, cash outflows and amounts invested over different time periods have no impact on the stated return. In other words, deposits, withdrawals and differences in amounts invested over different time periods have no material effect on the return value.
 
Internal Rate of Return
The IRR (also referred to as the dollar-weighted return) differs from the TWR in that it calculates the return rate at which the present value of cash outflows equals the present value of cash inflows. Its distinguishing characteristic is that cash inflows, cash outflows and amounts invested over different time periods do affect the stated return. In other words, deposits, withdrawals and differences in amounts invested at different time periods do have a material effect on the return rate.
 
Manual calculation of IRR involves a hit-or-miss process to find the rate of return that will equate the present value of the cash flows by manually substituting different rates of return to find the right answer. Thus, calculating the IRR typically involves the use of a computer or financial calculator.


Last Updated on Thursday, 29 April 2010 08:07