What Is Time-Weighted Return (TWR) and How to Calculate It?

Time-weighted rate of return (TWR) is one of the ways to evaluate your investments. It is used to calculate the overall return for each sub-period without considering additional cash flow. How do you calculate it, and when should you use it? We answer these questions in this article. Read on to find out more.

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What Is the Time-Weighted Rate of Return (TWR)?

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The time-weighted rate of return (TWR) is a commonly used metric to measure the performance of an investment, especially in situations where cash flows vary over time. Unlike the money-weighted rate of return, TWR removes the effect of cash inflows and outflows, making it an excellent measure when you want to evaluate the performance of an investment without considering the influence of deposits or withdrawals.

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TWR breaks down the investment period into separate sub-periods, calculates the return for each, and then compiles them together to determine the overall performance. This approach allows investors to see how their assets would have performed regardless of their personal actions.

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Time-Weighted Rate of Return Formula

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Before calculating the time-weighted rate of return, you need to divide the investment period into sub-periods, usually based on cash inflows or outflows. Then, you need to calculate the return rates for each period (R₁, R₂, etc.). For this, you need:

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• Ve—Ending value of the investment.
• Vb—Beginning value of the investment.

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Then, you can calculate the return rates using the following formula:

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R_x=(Ve_x-Vb_x)/Vb_x

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With that ready, you can proceed to the complete time-weighted rate of return formula:

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TWR = (1 + R1) * (1 + R2) * ... (1 + Rn) - 1

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How to Calculate Time-Weighted Rate of Return with Ease?

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Inputting data into the formula every time you need to calculate the TWR would require a lot of effort. This is why multiple tools can make it significantly easier. Financial calculators, spreadsheets, and wealth management platforms may all help you streamline this process and evaluate investments more quickly. Let’s look into this.

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Financial Calculators

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The first option you have is to use financial calculators. These have options specifically for calculating TWR (and even more complex formulas). How to use them?

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Let’s look at this based on a simple example. Imagine you have three periods with the following returns:

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• Period 1: 5% return
• Period 2: -2% return
• Period 3: 4% return

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Now you have to:

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• Convert the returns to decimalssome text
  • Period 1 return (R₁) = 5% → 0.050.050.05
  • Period 2 return (R₂) = -2% → −0.02-0.02−0.02
  • Period 3 return (R₃) = 4% → 0.040.040.04
• Add 1 to each period's return
  This adjusts the percentage returns for compounding:some text
  • 1+0.05=1.051 + 0.05 = 1.051+0.05=1.05
  • 1+(−0.02)=0.981 + (-0.02) = 0.981+(−0.02)=0.98
  • 1+0.04=1.041 + 0.04 = 1.041+0.04=1.04

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With all of the above ready, you can proceed with calculating the returns:

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• Calculate the first adjusted return:

• Type 1.05 (for Period 1),
• Press [×].

• Calculate the second adjusted return:

• Type 0.98 (for Period 2),
• Press [=] to calculate the result after multiplying the first two periods.

• Calculate the third adjusted return:

• Press [×],
• Type 1.04 (for Period 3),
• Press [=] to get the final compounded value.

• Subtract 1 to get the total return:some text
  • Press [−],
  • Type 1,
  • Press [=].
• Convert to a percentage:some text
  • Press [×],
  • Type 100,
  • Press [=].

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Microsoft Excel/Google Sheets

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You may also use Microsoft Excel or Google Sheets to calculate the TWR. Here, you’ll need to:

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• Input all your time periods, along with their beginning and end values, into your sheet (in separate fields).
• Create a separate column for period return rates. Use the following formula (A stands for the fields with beginning value, while B stands for fields with end period value):

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=(B_x-A_x)/A_x

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• Use the following formula to calculate the time-weighted return (C stands for your periodic return):

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=PRODUCT(1 + C_x:C_x) - 1

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WealthArc Platform

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If you want to simplify this process even further, there is a solution. You can use a wealth management platform, such as WealthArc. Such tools offer complex aid for wealth managers, with many different functions, including the calculation of the time-weighted return, so we highly recommend them.

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When to Use Time-Weighted Rates of Return? Pros and Cons

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The time-weighted rate of return has its own pros and cons that make it perfect for certain situations and least effective for others. Let’s look at those advantages and disadvantages and see when it is best to use TWR.

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Pros of Time-Weighted Rates of Return:

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• Removes the effect of cash flows, making it easier to compare investment performance across different time frames and investors.
• It enables you to validate and evaluate the whole strategy.

Cons of Time-Weighted Rates of Return:

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• It can be cumbersome to calculate, especially when there are multiple cash flows.
• TWR does not account for the impact of cash flows throughout the investment lifespan.

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When Does Time-Weighted Rate of Return Work Best?

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TWR is ideal when the objective is to measure how well an investment has performed without being influenced by external cash flows. You may use it to evaluate your whole strategy and, most importantly, to compare returns from different investments. However, if you want to see the investor's impact, it is better to use the money-weighted rate of return.

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The Takeaway

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The time-weighted rate of return is an effective tool in the hands of wealth managers. While, in theory, it is easier to measure than the MWR, there are no “ready” options to calculate it in financial calculators and spreadsheets. Therefore, if you want to estimate it with ease, consider in platforms like WealthArc—a complex hub for wealth managers, investors, and family offices.

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You may also read: The Importance of Data Accuracy in Financial Reporting