Why is Time-Weighted Return a Good Way to Track Performance in Retirement? - Rodgers & Associates
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Why is Time-Weighted Return a Good Way to Track Performance in Retirement?

There are a few different ways to track perfor­mance in a portfolio. The two most popular are Internal Rate of Return (IRR) and Time-Weighted Return (TWR). At Rodgers & Associates, we use a Daily Valuation Time-Weighted Return (TWR) method.

What does that really mean? Simply put, Time-Weighted Return breaks up the return on an investment portfolio into separate intervals. This allows us to measure perfor­mance based on the assets available for investment each given day, and then aggre­gates or links those daily returns for a longer period of time. This is designed to eliminate the effects of cash flows (dollars added into the portfolio or dollars taken out) and just score the portfolio on the invest­ments it holds.

The formula to calculate TWR is a little hairy but here it is…
TWR = [(1+HP1) X (1+HP2) x (1+HPn)] – 1

Where:
n= number of sub periods (in our case the number of days)
HP = (End Value – (Beginning Value + Cash Flow)) /(Beginning Value + Cash Flow)
HPn = Return for sub-period n

Side note: Fortu­nately, all of these calcu­la­tions are performed by our portfolio software!

We generally don’t look at returns over a very brief time horizon, but for the sake of example, here’s how a hypothetical return for a seven-day period would be calculated:

 Day Date n Beginning Value Cash Flow Ending Value HPn 1+ HPn Friday 2/1/2020 1 \$1,268,000 -\$4,000 \$1,280,000 0.01266 1.01266 Saturday (Market closed) 2/2/2020 2 \$1,280,000 \$0 \$1,280,000 0.00000 1.00000 Sunday (Market closed) 2/3/2020 3 \$1,280,000 \$0 \$1,280,000 0.00000 1.00000 Monday 2/4/2020 4 \$1,280,000 \$0 \$1,275,000 -0.00391 0.99609 Tuesday 2/5/2020 5 \$1,275,000 \$200,000 \$1,485,000 0.00678 1.00678 Wednesday 2/6/2020 6 \$1,485,000 \$0 \$1,493,000 0.00539 1.00539 Thursday 2/7/2020 7 \$1,493,000 \$0 \$1,490,000 -0.00201 0.99799

Cash Flow Interval 1 — Monthly distribution
Cash Flow Interval 5 — Roll over of cash from 401k

Sample 7‑Day Return Calculation

TWR = [(1+HP1) * (1+HP2) * (1+HPn)] — 1
TWR = [1.01266 * 1.00000 * 1.00000 * 0.99609 * 1.00678 * 1.00539 * 0.99799] — 1
TWR = 0.01896 or 1.896%

At Rodgers & Associates, our focus is on retirees and their financial needs so they can focus on enjoying themselves.  No matter what phase of retirement you are in, we think that using Daily Valuation-Time Weighted Return as the perfor­mance reporting metric is essential to achieve an accurate measure of how a portfolio has changed over time.

Origi­nally posted March 2020