Time-Weighted Return (TWR)

Time-Weighted Return (TWR) is a measure of a portfolio's Compound Growth Rate over a specific period. Think of it as the ultimate “fairness” metric for judging investment performance. It answers the simple, powerful question: “How would a single dollar, invested at the very beginning, have grown by the end?” The magic of TWR is that it completely neutralizes the distorting effects of cash flowing into or out of a portfolio. This is why professional fund managers and major market indexes use TWR to report their performance. It allows for a true apples-to-apples comparison of a manager's skill or a strategy's effectiveness, cleanly separating their investment choices from an investor's personal decisions to add or remove funds. If you want to know how good your strategy is, TWR is your go-to metric.

The TWR calculation is clever in its simplicity. Instead of looking at the entire investment period as one long timeline, it breaks the period into smaller chunks. A new “sub-period” begins every time cash is added or withdrawn. The process goes like this:

1. First, you calculate the simple return for each of these distinct sub-periods.
2. Second, you link these sub-period returns together by multiplying them. This method is known as Geometric Linking.

This process effectively 'resets' the calculation with every cash flow. It ensures that a large deposit you make right before a market rally doesn't unfairly inflate your performance figures, nor does a big withdrawal before a market dip make your strategy look worse than it was. It measures the performance of the money that was actually in the market during each specific period.

Let's say you're a diligent saver and want to measure your portfolio's performance over one year.

• Starting Point: You begin the year on January 1st with $1,000 in your account.
• Period 1 (Jan 1 - June 30): The market does well, and by June 30th, your account has grown to $1,200.
  1. The return for this first sub-period is: ($1,200 / $1,000) - 1 = 20%
• Cash Flow: On July 1st, you get a work bonus and deposit another $1,000. Your new account value is $2,200 ($1,200 from before + $1,000 new cash).
• Period 2 (July 1 - Dec 31): The market cools off, and by December 31st, your account value has fallen to $2,090.
  1. The return for this second sub-period is: ($2,090 / $2,200) - 1 = -5%

To find your Time-Weighted Return, you simply link the two sub-period returns:

1. (1 + 0.20) x (1 - 0.05) - 1
2. 1.20 x 0.95 - 1
3. 1.14 - 1 = 0.14

Your TWR for the year is 14%. This figure purely reflects how your investment selections performed, untainted by the size or timing of your bonus deposit.

To truly appreciate TWR, it helps to compare it to its main alternative, the Money-Weighted Return.

The Money-Weighted Return (MWR), also known as the Internal Rate of Return (IRR), is a different beast entirely. Unlike TWR, MWR is heavily influenced by the timing and size of your cash flows. It calculates the interest rate that equates all your contributions and the final value of your portfolio. In essence, it measures the performance of your money, including your decisions on when to invest it.

Think of it like judging a chef versus judging a meal you cooked at home.

• TWR is for the Chef's Recipe: TWR evaluates the quality of the investment strategy itself. It answers: “How good is this recipe?” This is what you use to compare Fund Manager A to Fund Manager B, or to see if your own stock-picking method is beating the S&P 500. It isolates the manager's skill from the investor's cash-flow timing. It is the industry standard for this reason.
• MWR is for Your Home-Cooked Meal: MWR evaluates your personal outcome. It answers: “How did my final dinner turn out?” This result is affected by both the quality of the recipe (the investments) and your decisions about when to add ingredients (your cash deposits). If you luckily add a huge sum right before a market surge, your MWR will be fantastic, even if the underlying strategy was merely average. It answers the question, “What was my actual, personal return?”

For followers of Value Investing, TWR is a particularly powerful and philosophically aligned tool. The value investing creed, championed by greats like Benjamin Graham and Warren Buffett, is about identifying wonderful businesses and holding them for the long term, allowing their value to compound. TWR perfectly reflects this mindset. It measures the pure, compounded performance of those carefully selected assets. It strips away the “noise” of an individual's saving and spending patterns (like adding to a portfolio after receiving a bonus), which are often entirely unrelated to the investment merits of the companies they own. For the patient, buy-and-hold investor, TWR helps answer the most fundamental question: “Are the businesses I chose compounding my wealth as expected over the long run?” It keeps the focus squarely on business performance, not on trying to time the market with cash flows.