In investment management literature, the terms "dollar-weighted ROI" and "time-weighted ROI" are often used.  These terms can be confusing, but need to be properly understood by both the individual investor and the investment professional.

 

Dollar-Weighted ROI is the same as the result of the "internal rate of return" (IRR) computation described previously in the section on ROI Computation Methodology. The term dollar-weighted is somewhat of a misnomer because, in fact, this ROI takes into account both the timing and amounts of investment cash flows. The dollar-weighting terminology is used most likely because it contrasts with the term time-weighted ROI.  This type of ROI is reported in Captools/net whenever the IRR-ROI notation is used in the Captools/net default field headers.

 

Time-Weighted ROI refers to a performance measure in which the dollar-weighting has been removed. It is used primarily to measure professional money manager performance.  It permits comparison between managers without the comparison being biased by differing amounts under management at different points in past market cycles.

 

Time-Weighted ROI is determined by calculating the mathematical average of a series of internal rate of return ROIs, each computed over relatively short, approximately equal, time periods. For example, a year might be broken into months and the individual ROIs for the months are then averaged using a multiplicative averaging method. This process effectively weights all sub-periods equally regardless of how much money was under management during any one sub-period.

 

Captools/net computes Time-Weighted rate of return using portfolio valuation dates to define the sub-periods used in the time weighting.  Professional users who need to comply with AIMR/GIPS standards (see AIMR/GIPS Compliance) should generate valuations at least monthly to obtain an accurate time-weighting effect over recent periods, i.e., the most recent 12 months.  Over longer terms, i.e., 5 or 10 years, retention of quarterly valuations should provide adequate time-weighting.  Time periods containing both weekly, monthly and/or quarterly valuations are weighted by Captools/net according to their length to avoid any bias due to variable length sub-periods. AIMR/GIPS also requires that sub-period breaks (i.e. valuations) be made whenever significant deposits or withdrawals are made from an account.  While this is usually easily implemented at the account level, at the security or investment class level, significant shifts between investments can lead to misleading results unless valuations are also performed at the rebalancing dates.

 

Captools/net time-weighted returns are indicated in reports by the notation Time-Weighted, Twtd or TW in the default field header, depending upon the type of report and available field width.  If you wish, these labels may be edited.

 

Non-professional investors using Captools/net should focus primarily on the IRR-ROI results. This is because Time-Weighted ROIs can lead to some misleading conclusions, particularly when used to measure the performance of any one portfolio.  In particular, it is possible for a money manager to produce a positive time-weighted ROI in a portfolio and still lose money for the customer.

 

For example, suppose that to try out a new money manager, you entrust him or her with $100,000 in January.  By the end of June, the manager has done very well and has increased your money to $150,000, a 125% annualized rate of return.  Suitably impressed, you give the manager another $85,000 to manage for the remainder of the year.  However, by year's end the manager has run your investment down to $75,000, or a -43.75% annualized rate of return for the second half.  On a non-time-weighted, internal rate of return basis (dollar weighted) your ROI for the year as a whole is -35%.  This makes sense, you have clearly lost money. From the money manager's perspective, however, it has been a good year.  On a time-weighted basis he made 12.5% for you, and in a "Bear Market" year, no less!