Return Matters: Part 1

“Doing something for the mere joy of it – for one’s self or others – is quite possibly one of the best returns on an investment of time that a person can receive.” – Laurie Buchanan, Ph.D. (author)

Perhaps someday, we’ll be able to explicitly measure the joy associated with how we spend our time – and maybe that will even have implications for how we approach financial planning. After all, it would be cool if we could estimate the likelihood of joy based on the path a person pursues and incorporate that with the financial side of the picture. But I digress. For now, we have a variety of return measurements to help assess investment managers, advisors, portfolios, and – of course – Alts. A basic understanding of “what’s what” across that return-measurement spectrum can have a lot of utility.

After laying a lot of groundwork for the edition of Alt Blend entitled Incoming: Part 4 –– we discussed the significant difference between taxable gain/loss and total return. Unsurprisingly, investors often assume the associated gain or loss shown on their account-holdings screen or statement is the same as the performance. It required four blog posts to differentiate between tax basis and total return properly, but I think we can be more efficient in exploring various return measures – and that’s the journey we embark on together today. Here we go!

Cash: to flow or not to flow?

The primary reason there are so many methods of calculating returns is that cash flowing into or out of a given investment has a meaningful impact on performance measurement. All anyone really wants to know is, “what is my return,” or “how did my investment do?” But those seemingly innocent questions open a whole can of worms because the honest answer is, “it depends on a few things – especially cashflows, but also what you care about measuring.”

The basics: TWRR and MWRR

It’s probably not apparent to most investors, but data that refers to “return” or “performance” of an investment or portfolio is typically referencing either TWRR or MWRR. These stand for time-weighted rate of return and money-weighted rate of return, respectively. Each is useful depending on the situation at hand, but – as we’ll see below – they can vary SIGNIFICANTLY.

Time-weighted Rate of Return (TWRR)

TWRR ignores the effects of cashflows and variation in portfolio value over time. For instance, imagine you’re adding money to your investment portfolio. In the first month, you have $100 invested, and it loses 50% (it is then worth $50). Then, at the start of month 2, you add $999,950, giving you an even $1 million. The return in the second month ends up being 10%. The result is that you have a total of $1,100,000, and you’ve gained $99,900. To calculate TWRR (aka “geometric return”), you basically just multiply the returns of each time period. In this case, the official calculation is (1-50%)*(1+10%) => (0.5%)*1.1 = 0.55, then subract 1 (which leaves -0.45) and multiply this by 100 to get to the final answer in percentage terms: -45%. Yes, even though you essetentially made $100k, your return is negative 45%!

Ignore the cashflows, and then this may be more intuitive. In the first month, you lost half of the original $100, leaving $50. Then you made 10% in the second month, which would have turned that $50 into $55. So, the investment is still down $45 from the original $100 – a -45% return. TWRR isn’t distracted by the cashflows or drastic changes in portfolio value like the human brain likes to be.

What is TWRR useful for? Well, it’s great for assessing investment manager performance. If you’re considering purchasing a mutual fund, and reviewing the return history (again, typically a terrible way to choose a manager), TWRR is precisely the performance measurement you want. Using the above example, you wouldn’t want the manager to tell you that the fund is up about 10% for the year just because a new large investor added a substantial amount of money in the second month. No, the performance of their underlying portfolio is really -45%. Thus, when you see investment returns of mutual funds and ETFs, TWRR is the calculation used. And more specifically, it’s usually net TWRR, meaning TWRR, which is net of all internal fees of the fund.

Money-weighted rate of return (MWRR…or IRR)

Also known as dollar-weighted return or internal rate of return (IRR), MWRR is more like what people assume to be the “return” of their portfolio. Again, using our above example, people would say their portfolio is up about 10% after the two months. As they essentially started with a million dollars, and now it’s grown to $1.1 million, losing $50 on the original $100 in the first month isn’t really relevant. In this case, the cashflows are an important part of the calculation. So, the math changes (and it’s actually a more complex calculation than TWRR, so we don’t need to get too into the weeds here), but the result is pretty intuitive. You invested $1,000,100 and now have $1,100,000. You’re up $99,900, which is 9.99%…or about 10% over the two months.

The math behind both TWRR and MWRR can become even more nuanced when we’re trying to understand annualized returns, but the goal of this current discussion is simply to provide a sense of what to watch out for and where these two common measurements can have utility.

How should portfolio returns be measured?

The industry standard is generally to use net TWRR. However, MWRR can also be valuable for making sense of certain portfolio decisions with your advisor. For instance, when averaging cash into a portfolio over time, comparing TWRR vs. MWRR can help shed light on whether or not that strategy ultimately paid off – strictly from a returns standpoint. Keep in mind that there are a number of other circumstantial factors that can make averaging into markets the right decision, such as making regular contributions from cashflow – or not wanting to do anything too drastic, such as when moving from a large cash position into equities. Emotionally, it’s easier to leg into the market, regardless of the short-term impact on returns.

Total return doesn’t care about taxes; taxable gain/loss doesn’t care about fees

As briefly touched on above, total return measures are typically net of fees (e.g., manager & advisory expenses), but they ignore taxes that have to be paid on capital gains or income (dividends or interest); that’s because taxes occur outside of the scope of a portfolio. On the other hand, the “gain/loss” displayed on a custodial site or account statements adjusts the cost basis of positions for any additions, subtractions, or dividends/income paid. It’s not that the custodian understands the specific amount of tax an investor pays; instead, it simply keeps track of which cashflow “events” affect cost basis and which do not. Again, check out Incoming: Part 4 for a specific example, but the takeaway is that taxable gain/loss can be VERY different from actual performance (aka total return).

But wait – there’s more!

Now that we’ve covered the basics, next time, we can move into an alphabet soup of return measurements, many of which are specific to Alts, like ROI, MOIC, TVPI, PME, and more. Stay tuned.

Until next time, this is the end of alt.Blend.

Thanks for reading,



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About the Author

Steven Tresnan, CAIA®, CFP®

Private Wealth Advisor

Steve is a Certified Financial Planner as well as a Chartered Alternative Investment Analyst®. He is also an Accredited Investment Fiduciary, which helps him offer guidance to clients with fiduciary responsibilities, such as board members of trusts, foundations, and endowments. Steve earned a Bachelor of Science degree in Industrial Engineering from Penn State University.

Steve serves on the board and finance committee of New Music USA – a national nonprofit devoted to the development and appreciation of new music in the U.S. – and volunteers as the Treasurer for Campus Fun & Learn, a child development center on the campus of Rockland Community College in New York.