Time-Weighted vs Money-Weighted Returns
Time-Weighted vs Money-Weighted Returns
Return is not return. The way you measure it determines whether you are looking at your skill, your luck, or something in between.
Key takeaways
- Money-weighted return (Internal Rate of Return) is your actual return, accounting for when you contributed and withdrew money.
- Time-weighted return (Geometric return) removes the effect of contributions, showing what a passive investor would have earned.
- Time-weighted is what fund managers use (to show skill independent of client deposits). Money-weighted is what you actually experienced.
- Most investors care about money-weighted return. Professional investors use time-weighted.
- An aggregator's "performance" number is usually time-weighted (or an approximation); your spreadsheet should calculate money-weighted.
The core difference
Imagine a simple scenario:
- January 1: You have $100,000 invested. The market returns 10% that year. By December 31, you have $110,000.
- You made $10,000, or a 10% return. Simple.
Now imagine a more realistic scenario:
- January 1: You have $100,000 invested.
- July 1: You contribute $50,000 (now you have $150,000).
- December 31: You have $160,000.
What was your return? This is where time-weighted and money-weighted diverge.
Money-weighted (what you care about): You put in $100,000 on Jan 1 and $50,000 on July 1, for a total of $150,000 invested. You ended with $160,000. Your net gain was $10,000 on $150,000 invested, or 6.67%.
But this is not quite right either, because you did not have the July contribution in the account for the full year. A more precise money-weighted calculation accounts for this timing: the Jan 1 contribution earned returns for 12 months, the July 1 contribution earned returns for 6 months. This is the Internal Rate of Return (IRR), and a spreadsheet or financial calculator computes it.
Time-weighted (what the market did): Between January 1 and July 1, your $100,000 grew to something higher (let us say $105,000, a 5% return). Then you contributed $50,000, bringing your total to $155,000. Between July 1 and December 31, this $155,000 grew to $160,000, a 3.2% return. The time-weighted return is the geometric mean of these two sub-periods: (1.05 × 1.032)^(1/1) - 1 = 8.3%.
The time-weighted return of 8.3% is what the market returned during that year, independent of when you happened to contribute. The money-weighted return of 6.67% (roughly) is what you actually earned, accounting for the fact that you contributed extra money late in the year and missed out on half the year's returns.
Why it matters
Money-weighted return is your reality. If someone asks, "How much did you earn on your investments last year?" the answer is the money-weighted return. It is the return that counts toward your actual wealth accumulation.
Time-weighted return is the market's reality. If you want to know, "Did the market do well this year?" or "Did my strategy beat the market?" you need to know the time-weighted return. This is also how professional fund managers report performance—they remove the noise of client deposits and withdrawals so you can see whether their stock-picking skill was any good.
Example: You are evaluating a mutual fund.
- Money-weighted return (what clients earned): 7% per year.
- Time-weighted return (what the fund itself did): 12% per year.
The difference? The fund had many new client deposits during a down market, so the average client's contributed money was weighted toward the cheap entry point. The fund itself earned 12%, but the average client, because they happened to put money in at the bottom, earned only 7%.
This difference is not the fund manager's fault; it is the luck of client timing. Time-weighted return removes this luck so you can see the manager's actual skill.
For your personal portfolio, you want money-weighted return because it is your actual experience. But you should also know your time-weighted return to see how much of your success (or failure) came from your choice of investments versus your luck in timing contributions.
Calculating money-weighted return
The simplest formula is:
Return = (Ending Value - Beginning Value - Net Contributions) / Beginning Value
Example:
- Beginning value (Jan 1): $100,000
- Net contributions during year: $50,000
- Ending value (Dec 31): $160,000
- Return: ($160,000 - $100,000 - $50,000) / $100,000 = $10,000 / $100,000 = 10%
This is a simplified money-weighted return. It assumes all contributions were made at the beginning of the year, which overstates the return slightly if you contributed later.
A more precise money-weighted return is the Internal Rate of Return (IRR). For this, you need a financial calculator or spreadsheet formula.
In Excel, use the XIRR function:
=XIRR(values, dates)
Where values are cash flows (negative for contributions, positive for the ending value) and dates are when those flows occurred.
Example:
- Jan 1: -$100,000 (contributed)
- Jul 1: -$50,000 (contributed)
- Dec 31: +$160,000 (ending value)
=XIRR({-100000, -50000, 160000}, {DATE(2024,1,1), DATE(2024,7,1), DATE(2024,12,31)})
This calculates the exact internal rate of return accounting for the timing of every cash flow. The result is usually between the simplified formula and the time-weighted return.
Calculating time-weighted return
Time-weighted return requires you to break the period into sub-periods, separated by each contribution or withdrawal. For each sub-period, calculate the return (ignoring new contributions). Then geometric mean the returns across all periods.
Example (continuing our scenario):
Period 1: Jan 1 to Jul 1
- Beginning: $100,000
- Ending (before contribution): $105,000
- Return: 5.0%
Period 2: Jul 1 to Dec 31
- Beginning (after contribution): $155,000
- Ending: $160,000
- Return: 3.23%
Time-weighted return: (1.05 × 1.0323)^1 - 1 = 8.4% (approximately)
This is tedious to calculate by hand, which is why aggregators do it for you. But now you understand what they are calculating and why it differs from your money-weighted return.
When to use each
Use money-weighted return for:
- Tracking your personal investment performance over time.
- Comparing your overall wealth growth year to year.
- Deciding whether to increase or decrease your contributions.
- Communicating your actual performance to a spouse, advisor, or heirs.
Use time-weighted return for:
- Evaluating a fund manager or advisor (it removes the noise of client deposits).
- Assessing your investment strategy's performance (independent of your timing luck).
- Comparing your performance to a benchmark that is time-weighted (like the S&P 500, which is published as a time-weighted return).
For your personal spreadsheet, calculate money-weighted return monthly or quarterly. You might also calculate time-weighted return annually as a reality check—it tells you what the market actually did, independent of your contribution timing.
A practical compromise
Many investors use a hybrid approach:
- Simple money-weighted return: (Ending Value - Beginning Value - Contributions) / Beginning Value. This is easy to calculate and is close enough for most purposes.
- Benchmark time-weighted return: Look up the time-weighted return of your benchmark (e.g., 70% VTI, 30% BND) from Vanguard or Morningstar. This tells you what the market did.
- Outperformance: Your return minus the benchmark return. This tells you whether your choices beat the market (negative numbers are normal and expected).
For example:
- Your money-weighted return: 8.2%
- Benchmark time-weighted return: 7.5%
- Outperformance: +0.7%
This tells you that you earned a higher return than your benchmark, but you do not know whether this is due to luck (contributing at the right time) or skill (picking better investments). Over many years and multiple market conditions, outperformance is usually luck—but it is worth tracking anyway.
Why aggregators use time-weighted
Personal Capital, Sharesight, and Morningstar all report time-weighted return (or an approximation of it) on your dashboard. They do this because:
- It is more comparable across time periods and across other investors.
- It removes the noise of your deposits and withdrawals, which are not the tool's responsibility.
- It shows the performance of the underlying investments independently of your contribution behavior.
But for your personal tracking, time-weighted return is less interesting than money-weighted, because you care about your actual wealth, not the theoretical wealth of a hypothetical investor who was fully invested the entire time.
The friction between the two
If your money-weighted return is much lower than your time-weighted return, it usually means you contributed heavily after the market had risen significantly. Conversely, if you contributed heavily after a crash, your money-weighted return will be higher than your time-weighted return (you got lucky).
Do not be discouraged if your money-weighted return is lower than the time-weighted return. This is normal in rising markets, and it just means your investment dollars entered the market during good times (when prices were high). This is not a failure of strategy; it is the nature of consistent savings.
Process
Next
You now know how to calculate return accurately. But return is only meaningful if you know what you are comparing it to. A 6% return sounds good until you realize the market returned 8%. The next article covers benchmarking: how to choose a fair standard and how to measure yourself against it.