Intro to Dollar-Weighting vs Time-Weighting Returns: Which Measures Portfolio Performance Better?
Why Measuring Investment Performance Matters
Whether you are a DIY investor checking your brokerage account or an advisor presenting quarterly reports, accurately measuring performance is critical. The two most common metrics—time-weighted return (TWR) and dollar-weighted return (DWR), often called money-weighted return or internal rate of return (IRR)—tell very different stories about the same portfolio. Knowing how each one works, when to use it, and what it really says about your skill can prevent costly misinterpretations and improve decision-making.
What Is a Time-Weighted Return?
Definition
Time-weighted return isolates the effect of market performance by removing the impact of cash inflows and outflows. In other words, it answers the question, “How did the investments I chose perform over time, regardless of when I added or withdrew money?” Because fund managers typically do not control client contributions, regulators and data providers prefer TWR for league tables and public reporting.
How It Is Calculated
The calculation breaks the total investment period into sub-periods every time cash moves. Each sub-period return is then geometrically linked. For example, if a portfolio gains 3 % in the first period and 2 % in the second, the time-weighted return is (1 + 0.03) × (1 + 0.02) − 1 = 5.06 %. Because deposits and withdrawals trigger new segments, the size or timing of those cash flows does not distort the final figure.
Strengths and Weaknesses
TWR excels at evaluating the skill of a portfolio manager or strategy. However, it can feel disconnected from an individual investor’s lived experience because it ignores when personal cash actually went to work. In addition, calculating precise sub-period returns requires detailed records and may be computationally intensive for accounts with frequent activity.
What Is a Dollar-Weighted Return?
Definition
Dollar-weighted return, or money-weighted return, measures the compound growth rate that sets the present value of all cash flows—deposits, withdrawals, and ending balance—to zero. It therefore reflects both investment performance and the timing of investor cash decisions. In practice, DWR is identical to internal rate of return used in corporate finance.
How It Is Calculated
Imagine you invested $10,000 on January 1, added $5,000 six months later, and ended the year with $17,000. A spreadsheet IRR function will iterate until it finds an annualized rate, about 11.8 % in this case, that equates the net present value of the cash schedule to zero. Larger contributions made just before a market upswing boost the DWR, while poorly timed additions diminish it.
Strengths and Weaknesses
DWR captures the real, “money-in-my-pocket” experience, making it great for evaluating household planning decisions or alternative investments with irregular distributions. The downside is that it conflates manager skill with investor behavior; a brilliant stock picker can look bad if clients pile in right before a downturn, whereas a mediocre manager can appear gifted when fresh cash coincides with a rally.
Illustrative Example
Suppose an index fund returns +20 % in Year 1 and −10 % in Year 2. Investor A invests $100,000 on day one and does nothing else. Investor B starts with $50,000 but adds another $50,000 at the beginning of Year 2. The two-year time-weighted return is the same for both investors: (1 + 0.20) × (1 − 0.10) − 1 = 8 %. Yet Investor A’s dollar-weighted return is also 8 %, while Investor B’s drops to roughly 2 % because the second-year deposit was hit by a decline. The gap illustrates how DWR embeds timing risk that TWR purposely strips out.
When to Use Each Metric
Use Time-Weighted Return When…
• You need to compare mutual funds, ETFs, or managers on an apples-to-apples basis.
• Regulatory standards or performance presentations (GIPS, CFA Institute guidelines) require it.
• Cash-flow decisions are outside the professional’s control.
Use Dollar-Weighted Return When…
• You are evaluating your personal financial progress toward goals such as retirement or college savings.
• Private equity, real estate, and other illiquid assets call capital over time.
• You want to measure the effectiveness of contribution and rebalancing strategies.
Tips for Investors and Advisors
1. View both numbers. TWR tells you how the selection of securities performed; DWR shows whether you added money at opportune moments.
2. Automate contributions. Systematic investing reduces timing risk and narrows the gap between the two measures.
3. Monitor cash drag. Large idle balances can weigh on dollar-weighted results even if TWR is stellar.
4. Avoid knee-jerk reactions. A low DWR can be a signal to improve behavior rather than replace a competent manager.
How Technology Simplifies Calculations
Modern brokerages and portfolio-management platforms automatically provide both metrics in dashboards and downloadable CSV files. Mobile apps increasingly show personalized IRR alongside benchmark TWR so clients grasp the effect of their own actions. For DIY investors, free spreadsheet add-ins and online calculators make computing DWR nearly as easy as looking up a ticker’s total return.
Key Takeaways
Time-weighted and dollar-weighted returns are complementary, not competing, measures. TWR isolates investment selection skill by neutralizing cash flows, making it ideal for performance rankings and manager evaluation. DWR weaves timing and behavior into the equation, painting a truer picture of an individual or fund investor’s lived outcome. Using both metrics side by side fosters better conversations, sets realistic expectations, and ultimately leads to smarter portfolio decisions.
Conclusion
The next time you open an account statement or app, note which return is displayed and ask yourself what question it really answers. Armed with an understanding of time-weighted versus dollar-weighted methodologies, you can interpret the numbers in context, celebrate genuine skill, and adjust strategy where behavior—rather than markets—is the main culprit. Mastering these two lenses on performance is a small step that yields big dividends in clarity and confidence.