What it means
Imagine two investors in the same fund. One invests a large amount before a good year, and the other invests the same amount before a poor year.
The fund itself had one performance, but their experiences differ, and the money weighted return captures that difference. The method treats each deposit and withdrawal as a cash flow at a date and finds the rate that discounts all of them to zero.
Because larger amounts held for longer count for more, the return is weighted by money, which is the reason for the name. A good run after a big deposit lifts the figure, while a bad run after a big deposit drags it down.
This makes it the right measure of an investor's own results, including the effect of their timing decisions. It is used to judge the experience of an individual investor, a private equity fund or a business whose treasury moves cash in and out.
It is not designed to judge how skilful a fund manager is, because the manager usually does not control when clients add or withdraw money. For manager evaluation, the time weighted return is preferred.
It removes the effect of cash flows by chaining together the returns of sub-periods, so that every dollar is treated alike. The two measures agree if there are no cash flows during the period, and they diverge when there are large flows.
Calculating the money weighted return generally needs a calculator or spreadsheet, because the rate has to be found by trial and error. Spreadsheet functions that find the internal rate of return, or the version for irregular dates, do this quickly.
The answer is only as accurate as the dates and amounts that go in.
In practice
Real-world examples
Example 1
An investor tops up her retirement fund each month. At the year end she wants to know her own return, including the effect of when she added the money. The money weighted return of 6.4% differs from the fund's published return of 7.0% because she added most of the money before a weak quarter.
Example 2
A private equity fund calls capital from investors in stages and distributes proceeds when it sells companies. The fund reports the internal rate of return, a money weighted figure, since the timing of calls and distributions is part of the outcome. Investors compare it with other funds.
Example 3
A company treasury invests surplus cash in a short-term fund and adds or removes money as its cash needs change. The finance director calculates the money weighted return to see what the treasury actually earned. The result is lower than the fund's headline return because large deposits were made just before a dip.
Think of it
Imagine driving a car where the speedometer shows your average speed, but the money-weighted return is like your actual fuel efficiency, which changes depending on whether you filled up right before hitting massive traffic jams or open highways.
Formula
Calculation
Find r such that: Initial investment x (1 + r)^T + Cash added x (1 + r)^(T - t) = Final value
Suppose an investor puts $100,000 into a fund at the start of year 1, adds $50,000 at the end of year 1, and the account is worth $176,000 at the end of year 2. Let x = 1 + r, so 100,000 x^2 + 50,000 x = 176,000. Testing x = 1.10 gives 100,000 x 1.21 = $121,000 and 50,000 x 1.10 = $55,000, which adds up to 121,000 + 55,000 = $176,000. The money weighted return is therefore 10.0% a year.Case study
Seen in the real world
Cedarline Foundation is an illustrative, fictional charity with an investment fund managed by an outside firm. In year 1, the fund returned 20% and in year 2 it returned -10%. The charity had $100,000 invested at the start of year 1 and added a further $200,000 at the end of year 1.
The time weighted return was (1.20 x 0.90) - 1 = 1.08 - 1 = 8.0% over two years, which is about 3.9% a year. But the charity had most of its money invested in the weak second year. Its balance at the end of year 1 was 100,000 x 1.20 + 200,000 = $320,000, which fell to 320,000 x 0.90 = $288,000.
The charity put in $300,000 in total and ended with $288,000, a loss, so its money weighted return was negative. The illustrative lesson is that the manager's performance was positive over the period, yet the trustees' experience was poor because of the timing of their large deposit.
Watch out
Common mistakes
- Using the money weighted return to compare fund managers, when it is affected by the timing of client cash flows that the manager does not control.
- Ignoring the dates of deposits and withdrawals, which are essential to the calculation.
- Assuming it equals the fund's published return, when the two differ whenever cash flows occur during the period.
Questions
People also ask
What is the difference between money weighted and time weighted returns?
The money weighted return reflects the investor's cash flow timing, while the time weighted return strips out the effect of cash flows to show the performance of the investments alone.
Is money weighted return the same as internal rate of return?
Yes, the calculation is the same, and the term money weighted return is used in investment performance reporting.
When is money weighted return the better measure?
When assessing the actual result for an investor who controls the timing of deposits and withdrawals, such as an individual or an investment committee.