As your investing journey progresses and as your portfolio rises and falls in value is it important to measure the performance of each portfolio in a way that is not distorted by incoming and outgoing cash flows.
How does InvestEngine calculate returns?
The return is the figure that reflects the money that your portfolio has gained or lost.
The time-weighted return (used in our platform) is the rate of return for multiple sub-periods based on changes in cash flow as outlined below.
Why is it useful to use time-weighted rate of return (TWRR)?
Due to the changes in cash flows your portfolio will have there are ways to measure performance which are not distorted by these events, as such InvestEngine calculates the performance of your portfolio on a time-weighted basis which is a method that eliminates cash flow effects to give a more accurate reading of your portfolio’s performance.
Time-weighted rate of returns are commonly used in indices and mutual funds. For example, the S&P 500 and the FTSE 100 Index are both measured on a time-weighted basis. As fund managers are not directly responsible for the cash flows into and out of the fund, including them in the return calculation would provide misleading results. This calculation method helps calculate the performance returns separate from cash flows.
Several InvestEngine customers pay into their accounts on a regular basis so it is important to exclude these cash movements in the performance of the portfolio.
Why do I have a positive TWRR % but a negative £ earnings? Or a negative TWRR % but a positive £ earnings?
The time-weighted rate of return shows the percentage gains that your investments have made since the start of your investment period. It provides a clear picture of the performance of your investments, not the impact of contributions or withdrawals.
Therefore, you can have a positive TWRR and negative earnings or the other way around.
This is caused by the timing of your contributions in relation to the market movements.
If you see a positive TWRR % but a negative £ earnings in your account, your % return is positive because your portfolio performance has been positive since you first started investing.
However, most of your payments were made when your portfolio’s performance was at its best, and performance has declined since. As a result, you have had less money exposed to the market when performance has been good, and more money exposed to the market when performance wasn’t as good.
For example, let’s say someone invests £100, and then gains a 50% return so that their portfolio is worth £150. Next, they pay in £10,000, but then the market goes down 10% straight afterward. This leaves them with £9,135. Their overall portfolio performance is positive because it went up 50% and then down 10%. However, they’ve made a loss of £965.
If you see a negative TWRR % but a positive £ earnings in your account, your % return is negative because your portfolio has decreased in value since you first started investing.
However, most of your payments were made when your portfolio’s performance was at its worst. Since then, your portfolio has increased in value.
For example, let’s say someone invests £100, and then they incur a 50% loss so that their portfolio is worth £50. Next, they pay in £10,000, and then the market goes up 10% straight afterward. This leaves them with £11,055. Their overall portfolio performance is negative because it went down 50% and then up 10%. However, they’ve made a gain of £955.
As extreme as these market moves appear to be, they illustrate the impact that a large cash flow (in respect to the portfolio’s previous amounts) can have on the performance of the portfolio.