What is a 'Money-Weighted Rate of Return'

Money-weighted rate of return is a measure of the performance of an asset or portfolio of assets. It is calculated by finding the rate of return that will set the present values of all cash flows and terminal values equal to the value of the initial investment. The money-weighted rate of return (MWRR) is equivalent to the internal rate of return (IRR).

BREAKING DOWN 'Money-Weighted Rate of Return'

There are many ways to measure returns for assets, and it is important to know which method is being used when reviewing asset performance. Money-weighted rate of return incorporates the size and timing of cash flows, so it is an effective measure for returns on a portfolio. Another popular return calculation is the time-weighted returns method.

Calculating Money-Weighted Rate of Return

A money-weighted rate of return is identical in concept to an internal rate of return; it is the discount rate on which the net present value (NPV) = 0, or the present value of inflows = present value of outflows. Start by identifying all cash inflows and outflows. When applied to an investment portfolio:

Outflows
1. The cost of any investment purchased
2. Reinvested dividends or interest
3. Withdrawals

Inflows
1. The proceeds from any investment sold
2. Dividends or interest received
3. Contributions

Example:
Each inflow or outflow must be discounted back to the present using a rate (r) that will make PV (inflows) = PV (outflows). For example, take a case where we buy one share of a stock for $50 that pays an annual $2 dividend, and sell it after two years for $65. Our money-weighted rate of return will be a rate that satisfies the following equation:

PV Outflows = PV Inflows = $2/(1 + r) + $2/(1 + r)2 + $65/(1 + r)2 = $50

Solving for r using a spreadsheet or financial calculator, we have a money-weighted rate of return = 17.78%.

Money-Weighted Rate of Return versus Time-Weighted Rate of Return

The money-weighted rate of return is often compared to the time-weighted rate of return, which many consider the industry standard because it is not sensitive to withdrawals or contributions. Fund managers tend to use the time-weighted rate of return in calculating the performance of mutual funds or broad-market indices. Time-weighted is defined as the compounded growth rate of $1 over the period being measured. The time-weighted formula is essentially a geometric mean of a number of holding-period returns that are linked together or compounded over time (thus, time-weighted). In short, MWRR differs in that it takes into account investor behavior via the impact of fund inflows and outflows on performance. If there are no cash flows then both methods should deliver the same or similar results.

Money-Weighted Rate of Return and Shortcomings

The money-weighted rate of return considers all the cash flows from the fund or contribution, including withdrawals. Should an investment extend over several quarters, for example, the MWRR lends more weight to the performance of the fund when it's at its largest size, hence the description "money-weighted." This can penalize fund managers because of cash flows that they have no control over.

Put simply, if an investor adds a large sum of money to a portfolio just before its performance rises, it equates to a positive action. This is because the larger portfolio benefits more (in dollar terms) from the growth of the portfolio that if the contribution had not been made. On the other hand, if an investor withdraws funds from a portfolio just prior to a surge in performance, it equates to a negative action. The now-smaller fund sees less benefit (in dollar terms) from the growth of the portfolio than if the withdrawal had not happened.

RELATED TERMS
  1. Average Return

    The simple mathematical average of a series of returns generated ...
  2. Time-Weighted Rate of Return

    The time-weighted rate of return is a measure of the compounded ...
  3. Annual Return

    Annual return is the compound average rate of return for a stock, ...
  4. Relative Return

    Relative return is the return an asset achieves over a period ...
  5. Profitability Index Rule

    The profitability index rule is a regulation for evaluating whether ...
  6. Modified Dietz Method

    The Modified Dietz Method calculates a portfolio's return using ...
Related Articles
  1. Investing

    Hedge Funds Topped $3 Trillion in 2016 Despite Rough Year

    Despite over $100 billion in outflows, the hedge fund industry topped $3 billion in total assets by the end of the year.
  2. Investing

    How to calculate your investment return

    How much are your investments actually returning? The method of calculation can make a significant difference in your true rate of return.
  3. Investing

    Equity Inflows Show Renewed Bullishness: BAML

    Investors are warming to risk as a bullish mood begins to take over, according to Bank of America Merrill Lynch's latest "Flow Show" report, released Thursday.
  4. Investing

    Vanguard Gets Bulk of Mutual Fund Industry Inflows During Q1

    Vanguard was the recipient of the lion's share of the $74 billion in mutual fund inflows the industry saw during the first quarter.
  5. Small Business

    Calculating IRR with Excel

    Find out how to calculate the internal rate of return on investments using Microsoft Excel, as illustrated in different investment scenarios.
  6. Investing

    Trends in Capital Flows: Global Equities

    Review trends in global equity mutual fund flows between 2013 and 2015, and discover what those trends say about broader investor behavior.
  7. Insights

    Wells Fargo Sees Big Outflows From Target Date Funds

    Wells Fargo is seeing large outflows from target date funds at a time when they are nearing record levels in terms of inflows.
  8. Managing Wealth

    Track Investments: 4 Top Portfolio Management Apps

    These four popular mobile apps can help you track your investments, test your investing choices and offer personalized advice for maximizing returns.
  9. Investing

    Funds with the Largest Outflows for September 2016 (PTTRX, FSAEX)

    The largest mutual fund and ETF asset outflows for September, 2016.
RELATED FAQS
  1. How do hurdle rate MARR and internal rate of return IRR relate?

    In capital budgeting, projects are evaluated by comparing the internal rate of return (IRR) to the hurdle rate, also known ... Read Answer >>
  2. What's the difference between absolute and relative return?

    Knowing whether a fund manager or broker is doing a good job can be a challenge for some investors. It's difficult to define ... Read Answer >>
  3. What are the disadvantages of using net present value as an investment criterion?

    While net present value (NPV) calculations are useful when you are valuing investment opportunities, the process is by no ... Read Answer >>
  4. What is the difference between yield and return?

    Return is the financial gain or loss on an investment. Yield measures the income, such as interest and dividends, from an ... Read Answer >>
Hot Definitions
  1. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  2. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  3. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  4. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  5. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  6. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
Trading Center