Of the many ways to measure an investment, time- and dollar-weighting are two of the most common. The time-weighted return on investment tells you how it performed objectively. If someone placed $1 in this asset for a period of time, what would they receive back? The dollar-weighted return on investment tells you how it performed subjectively. Here is how each works and which might be a good fit for you. You may also want to talk to a financial advisor to give you a better overall picture of your own investments and financial picture.
What Is Time-Weighted Return?
Time-weighted return measures the return on any investment in an asset over a defined period of time. It is the same for all investors. For example, say that a stock traded for $10 per share on Jan. 1 and by December 31 it traded for $11 per share. The annual, time-weighted return on this investment would be 10%, meaning that any investor who placed $1 in this stock on Jan. 1 would have $1.10 by December 31.
This is an objective measure because it reflects the return that any hypothetical investor would receive over the same period of time. As a result, time-weighted return is used to measure an asset’s performance against the market at large. You use this to determine how one investment compares with another or how an investment could theoretically perform compared with holding your money in cash. It is also the format in which most investment returns are written. When we write that the S&P 500 has an average annual return of around 11%, for example, this is a time-weighted return.
What Is Dollar-Weighted Return?
Dollar-weighted return measures the return that an individual investor would receive from an asset over a period of time based on their own pattern of investment, withdrawal and cash flow. It can differ for each individual investor.
For example, let’s say that you invest in a stock. Starting on Jan. 1 you invest $1,000 in various sums over the course of the year, buying shares based on the market at any given time. By Dec. 31 your shares are worth $1,200. Your dollar-weighted return on this investment would be 20%, meaning that your pattern of investment generated $200 of return on your $1,000 in total investments.
This is a subjective measure because it reflects the return that you personally will receive based on your own account management. As a result, dollar-weighted return is used to measure how well an investment would work for a given investor or to compare the likely performance that different investments might give an individual.
Time-Weighted vs. Dollar-Weighted Return
Time-weighted and dollar-weighted returns are identical for time periods in which there is no cash flow in an investment. If you place money in an investment at the start of the period and leave it there until the end, your dollar-weighted return will be the time-weighted return. These two metrics will differ for time periods in which there have been contributions or withdrawals. If you have a pattern of cash flow between the start of the period and the end of the period, that can lead to a different dollar-weighted return compared with a time-weighted return.
To understand this, consider a hypothetical stock in ABC Co. Over the course of one year, shares in ABC Co. move as follows:
Jan. 1, trading for $20 per share
March 1, trading for $25 per share
Aug. 1, trading for $18 per share
Dec. 31, trading for $22 per share
Now, take two investors.
Richard invested $500 on Jan. 1 and another $500 on March 1.
Julia invested $500 on Jan. 1 and another $504 on Aug. 1.
They would have the following results:
Richard invested $500 at $20 per share on Jan. 1, buying 25 shares of stock. On March 1, seeing the price go up, he invested another $500 at $25 per share, buying 20 shares of stock. On Dec. 31 he owned 45 shares of stock worth $990 (45 shares * $22 per share).
Richard’s Time-Weighted Return: 10% ($20 per share on Jan. 1 / $22 per share on Dec. 31)
Richard’s Dollar-Weighted Return: -0.01% ($1,000 overall investment over time / $990 investment value by the end of the period)
Any money that Richard invested on Jan. 1 grew by 10% at the end of the year, but his specific pattern of investments led to an overall loss of 0.01%, his dollar-weighted return.
Julia invested $500 on Jan. 1 at $20 per share, buying 25 shares of stock. Then, on Aug. 1, she invested another $504 at $18 per share, buying 28 shares of stock. On Dec. 31 her shares are worth $1,166 (53 shares * $22 per share).
Julia’s Time-Weighted Return: 10% ($20 per share on Jan. 1 / $22 per share on Dec. 31)
Julia’s Dollar-Weighted Return: 15% ($1,000 total investment over time / $1,166 overall investment value by the end of the period)
Julia has the same time-weighted value as Richard does. Any money that she invested on Jan. 1 grew by 10% at the end of the year. But her specific pattern of investments led to a positive return of 15%, her dollar-weighted return. They had a different dollar-weighted return because they had a different pattern of investment.
For investors, a time-weighted return will tell you the objective value of a given investment over time and how that investment compares with the rest of the market. A dollar-weighted return will tell you the subjective value of a given investment, what you personally would receive based on how you manage your money.
Bottom Line
Time-weighted returns tell you what an investment has returned over a single period of time with no cash flow. Dollar-weighted returns tell you what an investment has returned over a period of time based on an individual investor’s pattern of investing. Using either could be a potential help in determining how you’re successfully investing your money.
Investment Tips
Whenever we talk about cash flow and moving in and out of your investments, it’s always a good opportunity for this reminder: You can’t time the market. Please don’t try.
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