2 key returns you have to understand!

The performance of your investment portfolio is, in reality, a very simple calculation but statements can sometimes be confusing and statements sometimes show different numbers.

We will explain the two different calculation methods that are being used and go over how they each tell a correct but different picture of the performance of your investment portfolio.

The two common ways to report the returns are a time-weighted rate of return and dollar-weighted rate of return.

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The dollar-weighted method looks at the dollar amount in the portfolio at the beginning of the period and compares it to the dollar amount in the account at the end of the investment period.

This type of measurement is highly affected by the timing of which new money is being contributed to the account as well as affected by money being pulled out of the account.

If large amounts of monies are added to an account during a good performance that will positively affect the calculated rate of return for the period.

The method looks more at the timing of the investor and does not showcase the performance of the underlying funds.

 

The other method called time-weighted rate of return looks at how much your investments returned on average and does not look at how much was deposited and the timing of the deposits.

Basically, this method will show how well the underlying investments performed during the specified period and it will not look at cash flows within the account.

 

 Looking at returns should always be done with your money in mind and you should always find the actual rate of return.

 

The only true fair method to evaluate the return of a portfolio and to compare it to benchmarks and other investments it to look at the time-weighted rate of return method.

Since portfolio managers and funds can’t control how an investor moves money in and out of their portfolio it would only be fair, from a comparison standpoint, to use this method.

 

Looking at returns should always be done with your money in mind and you should always find the actual rate of return.

The average rate of return, using the time-weighted method, will show what the portfolio did on average but that may not be what you actually experienced.

We will illustrate this with an easy example.

 

Tiffany invested $100,000 dollars in a portfolio and at the end of year one in the portfolio she experienced a -20% rate of return.

Year 2 in the portfolio she experienced a +20% rate of return which would give the portfolio an average 0% rate of return.

So the portfolio can show that over the last 2 years it has on average returned 0% but for Tiffany that means nothing as she actually would have a negative return.

She would at the end of year 2 have $96,000 so her real rate of return would not be 0% but actually negative as she would have lost $4,000*

So always pay attention to how the rate of returns are calculated and understand what is happening in your portfolio but more important stay within your objectives and risk profile and think long term.

*100,000*0.8=80,000

80,000*1.2= $96,000

Written by CreativeNurse Team

2016-24859  Exp. 6/18