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The money-weighted return is a useful tool to track your personal investment performance. In this article you will learn what the money-weighted return means in detail, how you can determine themwhen it applies and which advantages and disadvantages it holds.
You'll also learn how money-weighted returns differ from other measures of return, such as simple and time-weighted returns. Are you ready to deepen your financial knowledge? Then let's get started!
The money weighted return (MWR) is a method of calculating the return on an investment. It measures your investment experience as an investorby taking into account when and how much money you invested and at what point in time. Therefore, MWR is particularly useful when there are multiple cash flows and you are regularly depositing or withdrawing money.
sThe money-weighted return gives you a detailed picture of this, how good your personal investment decisions wereby including deposits and withdrawals and their timing in the calculation.
Calculating the money-weighted return can seem complicated at first, especially when there are many cash flows. In this section you will learn a Step-by-step instructions for calculating the MWR which turns the complexity into a simple calculation. After the tutorial, you can experience the theory in practice with an example. Here is the guide to the Calculation of the money-weighted return in three steps:
If this seems too complicated or if you would rather save your time, you can use a Free tool like Portfolio Performance do this work for you.
Here is the practical calculation example:
You invest CHF 1,000 in a portfolio and after one month it is worth CHF 1,050. You decide to invest a further CHF 2,000 and at the end of the next month the entire portfolio is worth CHF 3,150.
The cash flows are therefore:
Month 1: Deposit CHF -1,000
Month 2: Deposit CHF -2,000
Month 3: Payment CHF +3,150
The correct equation is:
1000 + 2000 / (1 + r) = 3150 / (1 + r)^2
or after conversion:
1000 (1 + r)^2 + 2000 (1 + r) = 3150
Use the IRR/IKV function in Excel or Calc to obtain the solution:
r = 3.72 % per month
For the entire two-month period:
(1 + r)^2 - 1 = 7.57 %
The money-weighted return in the example is therefore 7.6 % over two months.
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Although the money-weighted return is more complex to calculate, it gives you a sA personalised view of your investments. Therefore, MWR is particularly useful in the following scenarios:
Although the money-weighted return is useful, it also has its limitations, which you will learn about in the next section.
The money-weighted return provides a Variety of advantagesHowever, it also brings Challenges with. Here are the main advantages and disadvantages:
Now that you have learned about the advantages and disadvantages, you can see a direct comparison with other methods of calculating returns.
As already mentioned, the return on your portfolio is an important indicator of the success of your investment. In addition to the money-weighted return, there are other ways of calculating returns. Each method has its advantages and disadvantages. The two most common other calculation methods are the simple and the time-weighted return.
In the calculation example, the initial value is CHF 1,000 and the final value is CHF 3,150. The simple return in this case would be 5 %
(CHF 3,150 / (CHF 1,000 + CHF 2,000)) = 1.05 or 5 %).
The time-weighted return measures the pure portfolio performance, regardless of the time of the deposits.
Return in the first month:
1050 / 1000 = 1.05 = 5 %
Return in the second month:
3150 / 3050 = 1.0328 = 3.28 %
The total return is calculated by multiplying the monthly factors:
TWR = (1.05 * 1.0328) - 1 = 0.0844 = 8.44 %
Comparison of the results of all three yield calculation methods:
| Cash flow | Date | MWR | ER | TWR |
|---|---|---|---|---|
| CHF - 1'000 | 01.01.2023 | 3.72 % p.m. (7.57 % total) | 5 % | 8,44 % |
| CHF - 2'000 | 01.02.2023 | |||
| CHF 3'150 | 01.03.2023 |
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The Money-weighted return is a useful tool to measure the performance of your investments and calculate the net return.. However, it is important to use them in combination with other metrics and information to get the full picture.
After reading this article, you will have a better understanding of money-weighted returns and how to use them in your investment process. Investing requires patience, discipline and continuous learning, but with the right tools and information you can start on the path to financial success.
Do you have any other questions about the topic or are there any other financial topics you would like to discuss? Feel free to use the comment function!
An error has also crept into the presentation of the time-weighted return TWR.
The two-month yield r2 is obtained by multiplying the interest factor of the first month a by that of the second month b and then subtracting 1:
a = 1050/1000 = 1,05
b = 3150/3050 = 1,032787
r2 = ab - 1 = 8.4426%
Thanks for the tip, Christian! The formulas have now been corrected 🙂
Hello Eric, that looks good now!
Only in the case of the simple return does the text not really fit the calculation. The latter is correct in principle, except that the minus one is missing.
r2 = 3150/(1000 + 2000) - 1 = 5%
In the description, however, it should somehow read like this:
The sum of all incoming payments minus the sum of all outgoing payments equals the cash flow total.
With this and the final value, the simple return for two months is then calculated as:
r2 = (terminal value - cash flow total) / cash flow total
Or remodelled:
r2 = terminal value/cash flow total - 1
The simple return per month r is then calculated as follows:
r = root(1 + r2) - 1 = root(1.05) - 1 = 2.47%
And of course the incoming and outgoing payments are included in the cash flow total in the simple return (only the timing is not).
Best regards, Christian
The calculation of the money-weighted return MWR is unfortunately presented incorrectly.
The equation to be solved is:
1000 + 2000/(1+r) = 3150/(1+r)^2
Or in the variant obtained by multiplying by (1+r)^2:
1000 (1+r)^2 + 2000 (1+r) = 3150
Both lead to the solution:
r = 3.7155%
In Excel or Calc, the same value r is obtained using the function for the internal rate of return IKV:
r = IKV({1000;2000;-3150})
And r is not the return for the two-month period, but the return for one period, i.e. for one month.
The return r2 for the two-month period is calculated as follows:
r2 = (1+r)^2 - 1 = 7.569%