Time-weighted vs money-weighted returns: a plain guide for small RIAs
A time-weighted return measures how the investments performed, with the effect of deposits and withdrawals removed, so it's the fair way to judge a strategy or compare it with a benchmark. A money-weighted return measures how the client's actual dollars did, including when they added or took money out. The two can differ widely in a year with large cash flows, and both can be correct.
A client looks at her year-end report and asks, "So how did I do?" She might mean "how did my investments perform?" or "how did my money do?" In a year when she added or withdrew a large sum, those two questions have different answers. Time-weighted and money-weighted returns exist so you can answer each one honestly, and say which one you're answering.
What is a time-weighted return?
A time-weighted return measures the investments' performance with the effect of cash flows removed. The period is split at every deposit or withdrawal, the return for each sub-period is calculated, and the sub-period returns are linked together by multiplying them. The result describes how the portfolio did regardless of when the client added or took money.
- It's the fair measure for judging a strategy or a manager, because the manager doesn't control when the client deposits.
- It's the right measure to compare against a benchmark, which has no client cash flows.
- It needs a valuation on each cash flow date. Daily data makes that accurate.
What is a money-weighted return?
A money-weighted return is the internal rate of return of the account's cash flows, so it includes the timing and size of every deposit and withdrawal. If a client added a large sum just before a rise, their money-weighted return comes out better than the strategy's. Just before a fall, worse.
- It describes the client's own experience with their own dollars.
- It isn't a fair way to judge the strategy, because it rewards or penalises timing the manager didn't choose.
Why do large deposits and withdrawals distort a simple return?
Because a start-to-end comparison counts new money as growth and withdrawals as losses. An account that went from $100,000 to $228,000 looks like it more than doubled, even if most of that increase was a deposit. Both measures exist to strip that out, in different ways.
How do the two compare on the same account?
Here's a hypothetical account, with round numbers chosen to make the arithmetic easy to follow. These are not real or expected returns.
| Date | Event | Value |
|---|---|---|
| Jan 1 | Starting value | $100,000 |
| Jun 30 | Portfolio is down 10% for the half | $90,000 |
| Jun 30 | Client deposits $100,000 | $190,000 |
| Dec 31 | Portfolio is up 20% for the half | $228,000 |
Now the three ways to describe the year:
| Measure | Calculation | Result |
|---|---|---|
| Simple start-to-end | ($228,000 minus $100,000) divided by $100,000 | 128% (counts the deposit as growth) |
| Time-weighted | 0.90 times 1.20, minus 1 | 8.0% |
| Money-weighted (IRR) | Rate at which $100,000 for a year plus $100,000 for half a year grows to $228,000 | About 18.9% |
The 128% figure is meaningless as a return. The time-weighted 8.0% says how the strategy did across the year. The money-weighted 18.9% says the client's dollars did better than that, because more of them were invested during the strong second half. Neither of the last two is wrong. They answer different questions.
What should you tell clients?
Label which measure you're showing, and say in one sentence what it answers. If you show only one, the time-weighted return is the one to put next to a benchmark. If a client's deposits and withdrawals made their experience very different from the strategy's, a money-weighted figure helps explain why their account feels better or worse than the report says.
The conversation that goes badly is the one where a client sees a time-weighted 8.0% and knows they put in $100,000 and now have $228,000. A short note on the report saves that call.
When does the difference not matter much?
In an account with no deposits or withdrawals during the period, the two measures give the same answer. With small flows relative to the account size, they'll be close. The gap only becomes worth explaining when flows are large compared with the balance, or land just before a big move. For a firm whose clients mostly leave money alone between reviews, one well-labelled measure is usually enough.
How Advorra reports performance
Advorra shows time-weighted performance, allocation and concentration per account and household from the custodian's data. A server-side performance engine that also handles money-weighted returns, benchmarks and risk statistics is part of what we are building next. To see how time-weighted performance looks per household today, visit the product page.
An explanation of measurement methods, not investment advice. Performance reporting must follow your firm's policies and any applicable rules.
Questions advisors ask
Can the money-weighted return be higher than the time-weighted return?
Yes. If a client added money just before a strong stretch, their dollars did better than the strategy's average, so the money-weighted figure comes out higher. It works the other way before a weak stretch.
Does a time-weighted return need daily data?
It needs a valuation on each date money moves in or out. Daily valuations make that simple and accurate; with monthly values, flows inside the month have to be approximated.
Is a money-weighted return the same as an IRR?
Yes. A money-weighted return is the internal rate of return of the account's cash flows: the starting value, each deposit and withdrawal, and the ending value.
Which figure should go in a quarterly client report?
Label whichever you show and say what it answers. One approach is to lead with time-weighted for comparison against a benchmark, and add money-weighted when a client's own flows made their experience very different. Follow your firm's reporting policy.
Is this investment advice?
No. It is an explanation of two measurement methods. Performance reporting must follow your firm's policies and any applicable rules.
See it on a demo firm
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