The Money-Weighted Rate of Return (MWRR), also known as the Internal Rate of Return (IRR), is a method used to calculate an investment's performance by considering the timing and size of all cash flows into and out of a portfolio. Think of it as your personal rate of return. It doesn't just measure how well your chosen investments performed; it also measures how well you performed as an investor, including your decisions on when to add more money or take some out. Because it's heavily influenced by your cash flow decisions, the MWRR provides a true picture of your portfolio's growth based on your actions. It answers the simple, all-important question: “Given all the money I've put in and taken out, what was my actual, personalized annual return?” This makes it different from other metrics that just look at the performance of the fund manager.
The MWRR is all about the impact of your timing. If you have the good fortune (or skill) to add a large sum of money right before a market surge, your MWRR will look fantastic. Conversely, if you pull money out just before a rally or pour it in right before a crash, your MWRR will suffer, even if the underlying investments eventually recover.
At its heart, the MWRR is the unique interest rate (or “discount rate”) that makes the present value of all your cash infusions (deposits) equal to the present value of all your cash withdrawals, including the final value of the investment. In simpler terms, it's the single rate of return that explains your portfolio's journey from its starting value to its ending value, accounting for every deposit and withdrawal along the way. You don't need to do the complex math by hand! Financial calculators and spreadsheet programs are your best friends here. For example, Microsoft Excel's `=XIRR` function is designed specifically to calculate the MWRR for a series of cash flows on irregular dates.
Imagine two friends, Alice and Bob, who both invest in the exact same index fund over two years. The fund returns -10% in Year 1 and +30% in Year 2.
After two years, who did better? While they invested in the same fund, their personal returns are vastly different. Alice’s return is simply the fund's geometric average. Bob’s return, however, is much higher. Why? Because he had significantly more money in the game during the fantastic second year. The MWRR would capture this perfectly, showing Bob's superior return due to his (lucky or skillful) timing. It reflects the fact that his capital was weighted more heavily toward the period of strong performance.
Understanding the difference between MWRR and its famous cousin, the Time-Weighted Rate of Return (TWRR), is key to using them correctly.
So, which one matters? Both! Use the TWRR to pick a good fund manager, and use the MWRR to grade yourself on how you’ve managed your own contributions and withdrawals over time.
For a follower of Value Investing, the MWRR is a powerful tool for self-reflection. While value investors famously avoid trying to “time the market” in the short term, they absolutely aim to be opportunistic. As Warren Buffett advises, they should be “fearful when others are greedy, and greedy when others are fearful.” The MWRR can serve as an honest scorecard for this discipline.
Ultimately, the MWRR isn't about celebrating your ability to predict the market's every move. Instead, it’s a mirror that reflects the financial consequences of your actions, helping you become a more disciplined and self-aware investor.