How do investors evaluate the performance of their portfolio? Very often, the first metric to turn to is returns. Yet, there are different ways of calculating returns, and each method can tell a different story.
When you log into your Syfe account, you will see two different returns displayed, “net return” and “TW return”. TW return stands for time-weighted return, and it’s one of the most useful metrics to evaluate how well Syfe has managed your portfolio.
Understanding Time-weighted Return
You can think of time-weighted return as the change in value your portfolio would have experienced if all the funds you’ve ever deposited were invested at the same moment as your very first deposit. Simply put, it removes the effect of cash deposits and withdrawals on your portfolio. This is important because when money is flowing in and out of a portfolio, your actual rate of return can get distorted.
The time-weighted return is considered the gold standard in comparing investment performance across different portfolios. In essence, time-weighted return only reflects the impact of the market and how well your portfolio has been constructed by measuring your portfolio’s compounded rate of growth over a specific time period.
To calculate time-weighted return, you can use the formula below.
TWR = [(1 + HP^1) x (1 + HP^2) x … x ( 1 + HP^n )] – 1
TWR = Time-Weighted Return
n = Number of Periods
HP = (End Value – Initial Value + Cashflow)/(Initial Value + Cashflow)
HP^n = Return for Period “n”
Let’s say you invested $10,000 in Portfolio A on December 31 2018. By 30 June 2019, your portfolio has lost money due to market fluctuations and your portfolio value is $9,600. You then make an additional $10,000 deposit. By the end of 2019, your portfolio value increased to $23,000.
Your return (HP) for the first period would be: ($9,600 – $10,000) / ($10,000) = – 4%
Your return (HP) for the second period would be: ($23,000 – ($9,600 + $10,000)) / ($9,600 + $10,000) = 17%
Your time-weighted return is then: [(1 + (-4)%) X (1 + 17%)] – 1 = 12%
This is just a simplified example. In reality, calculating time-weighted return on your own can be much more complicated. Cash flows in and out of your account can be tough to calculate, which is why Syfe uses software and algorithms to track these data accurately.
Comparing Time-weighted Return and Net Return
At Syfe, we show our customers two return metrics on their portfolio dashboard. Although time-weighted return is the industry standard, it may not be as helpful in showing how much you benefited in dollar terms from your portfolio performance. That’s why we provide a net return figure displayed as both a dollar amount and return percentage.
Net return = Earnings / Net investment
Going back to our earlier example, your net return would be: $3,000 / $20,000 = 13%
You invested a total of $20,000 and you gained $3,000 by the end of the year. But while net return is simple to understand, it can be easily distorted by cash flows. Let’s say you decide to withdraw everything in your portfolio, all $23,000 of it. Your net return will now be: $3,000 / ($20,000 – $23,000) = -100%
Even though you gained $3,000 from your portfolio, your net return will be reflected as a negative return, which isn’t reflective of your true portfolio performance.
Consider The Impact Of Time
While time-weighted return can help you compare the performance of your Syfe portfolio against other portfolios, the metric is only representative when seen over a long period of time. If you’ve only invested for a few months, the time-weighted return is unlikely to reflect the true performance of your portfolio.
Ideally, you’d want to consider the annualised time-weighted return over 10 years or more. Markets behave cyclically, so there will be good years interspersed with not-so-good years. To see the past returns of Syfe’s portfolios, click here to view our sample portfolio.
Ultimately, what matters is staying invested for the long haul. Time in the market is better than timing the market; despite significant market crashes such as the Great Depression in the US, the 9/11 attacks and the financial crisis of 2018, over any 20-year period, the US stock market has never lost money.
The stock market has historically favoured investors who take a long-term approach. With average returns trending positive over longer horizons, it pays to commit to a long-term investing strategy and stay invested, even if stock market returns can vary greatly from year to year.