The time-weighted rate of return measures the compound growth rate of $1 initial investment over the measurement period. Time-weighted means that returns are averaged over time. This approach is not affected by the timing of cash flows; therefore, it is the preferred method of performance measurement.
Example
Jayson bought a share of IBM stock for $100 on December 31, 2000. On December 31, 2001, he bought another share for $150. On December 31, 2002, he sold both shares for $140 each. The stock paid a dividend of $10 per share at the end of each year.
To calculate the dollar-weighted rate of return, you need to determine the timing and amount of cash flows for each year, and then set the present value of net cash flows to be 0: - 100 - 140/(1 + r) + 300/(1 + r)2 = 0. You can use the IRR function on a financial calculator to solve for r to get the dollar-weighted rate of return: r = 17%.
To calculate the time-weighted rate of return:
For the second year:
Learning Outcome Statements
d. calculate and compare the money-weighted and time-weighted rates of return of a portfolio and evaluate the performance of portfolios based on these measures;status | not read | reprioritisations | ||
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