What it means
Imagine two investors who both hold the same fund. One puts in a large sum just before a market fall, and the other adds money just before a rise.
A simple calculation of their gains would give very different answers, even though the fund itself did exactly the same for both. The time weighted method fixes this by measuring the return in each sub-period between cash flows, and then chaining those returns together by multiplication.
Because each sub-period is measured on the value at its start, the size and timing of deposits stops affecting the answer. What is left is the pure performance of the investments.
This is why the method is the industry norm for reporting the performance of funds and portfolio managers. The manager decides what to buy and sell, but the client decides when to contribute or withdraw, so judging the manager fairly means ignoring the client's timing.
The contrast is the money weighted rate of return, sometimes called the internal rate of return, which does reflect the timing of cash flows. It answers a different question, namely how well the investor's own money did, given when they added or withdrew funds.
The two figures can differ a lot when large cash flows arrive at awkward times. In practice the calculation needs a valuation of the portfolio each time cash moves in or out.
With daily pricing this is easy, and with illiquid assets such as property it is harder and often relies on estimates, so the result is less precise. Finance teams use it to evaluate pension fund managers, to check incentive fees, and to compare investment options.
Whenever a report says that a fund returned a given percentage over a year, it is usually quoting a time weighted figure.
In practice
Real-world examples
Example 1
A pension trustee compares two investment managers over three years. She uses time weighted returns so that neither manager is favoured or penalised by the timing of employer contributions into the fund.
Example 2
A financial adviser prepares a report for a client who withdrew $30,000 for a house deposit midway through the year. The adviser reports a time weighted return to show how the portfolio performed, independent of the withdrawal. She adds a separate note explaining how the client's own money fared, so the client sees both views.
Example 3
A foundation reviewing its endowment sees a manager's reported return of 8%. The finance officer checks that the number is time weighted and uses it to compare with the benchmark index.
Think of it
Imagine testing a car's engine performance on a racetrack. Every time someone hops in or out of the car, you pause the stopwatch to measure how fast the engine itself is running, ensuring passenger weight changes do not skew the speed test.
Formula
Calculation
Time weighted return = [(1 + R1) x (1 + R2) x ... x (1 + Rn)] - 1
where each R is the return for a sub-period between cash flows
An investor starts with $100,000. After six months it grows to $110,000, a return of (110,000 - 100,000) / 100,000 = 10%. The investor then adds $50,000, making the value $160,000. By year end it reaches $168,000, a return in the second period of (168,000 - 160,000) / 160,000 = 5%. Time weighted return = (1 + 0.10) x (1 + 0.05) - 1 = 1.10 x 1.05 - 1 = 1.155 - 1 = 0.155, or 15.5%.Case study
Seen in the real world
Windrush Pension Trust is an illustrative, fictional scheme that employed two managers to invest equal amounts. One manager reported a 12% annual return and the other 9%, and the trustees were ready to dismiss the second.
The scheme's finance officer noticed that the second manager had received a large contribution of $20,000,000 just before a market dip, while the first had received no new money. The figures being compared were not on the same basis.
She recalculated both on a time weighted basis, and the second manager actually produced 11.6% against the first manager's 11.9%. In this illustrative story, the trustees kept both managers and agreed that all future reports must use the time weighted method. The finance officer also asked the managers to show the sub-period returns in their reports, so the trustees could see exactly how each figure was built and check the multiplication themselves.
Watch out
Common mistakes
- Comparing a fund manager's return with an investor's own gain, when the investor's gain is affected by the timing of deposits and withdrawals.
- Adding sub-period returns together instead of multiplying, which gives the wrong answer, especially over longer periods.
- Forgetting to value the portfolio on every cash flow date, which makes the result inaccurate.
Questions
People also ask
When should I use money weighted return instead?
Use it when you want to know how your own money did, given your personal timing of deposits and withdrawals.
Why is time weighted return the industry standard?
Because managers do not control client cash flows, and the method lets different managers be compared on equal terms.
Does a time weighted return include fees?
It can be shown before or after fees, so always check which one is quoted before comparing funds.