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Time versus money-weighted returns


Lupo Lupus
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What are you using to measure performance, and why?

 

I am talking here from the perspective of a private investor (considerations for portfolio managers who face passive inflows are obviously different).

 

Basically, I am seeing a trade-off. On one hand, money-weighted returns will also capture your asset allocation skills. Eg, converting spare cash to equity when prices are low and expected returns are high.

 

But on the other hand, inflows in most people's portfolios are to some extent passive. For example everybody who mechanically adds new savings to the equity portfolio has effectively passive inflows. Using money-weighted returns will then add noise to the measurement of skills.

 

I am currently using money-weighted returns, as they are easier to calculate for me (given the way I record my trades).

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Basically, I am seeing a trade-off. On one hand, money-weighted returns will also capture your asset allocation skills. Eg, converting spare cash to equity when prices are low and expected returns are high.

 

Asset allocation decisions should not affect your return calculations, whether you use MWRR or TWRR. Asset allocation changes happen within the portfolio; they are internal portfolio flows.

 

It sounds like you are excluding cash from your return calculations. I think it's a wrong way to go. Suppose the market returns 10% a year. You are 90% in cash, 10% in stocks. Your stocks return 30%. Did you beat the market or not? On a total portfolio basis you didn't.

 

I track MWRR across all family accounts I manage, cash included.

 

I don't bother to track TWRR mostly because it's too much work. I can approximate my long-term TWRR by calculating the geometric average of the annual MWRRs. It's not an accurate method but it's good enough for rough comparisons with the benchmark.

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