Performance: Time Weighted Return vs. Internal Rate of Return

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You've provided a clear explanation of the differences between Simple Rate of Return (SRR), Internal Rate of Return (IRR), and Time Weighted Return (TWR), which are all measures of investment performance. Let's summarize the key points:

  1. Simple Rate of Return (SRR):

    • Measures the percentage change in market value.
    • Often used for benchmarks or indices where there are no cash flows.
    • Simple to calculate but not suitable for analyzing an individual's investment portfolio.

  2. Internal Rate of Return (IRR):

    • Also known as dollar-weighted return.
    • Measures a portfolio's actual performance between two dates, considering cash inflows and outflows.
    • Gives more weight to time periods with higher investment amounts.
    • Useful for assessing whether a portfolio is meeting specific financial goals.
    • Not ideal for analyzing underlying asset performance or comparing different investment managers.

  3. Time Weighted Return (TWR):

    • Captures the true performance of the underlying assets by eliminating the effects of capital additions and withdrawals.
    • Reflects the return on the very first dollar invested in the portfolio.
    • Calculated by dividing the performance period into sub-intervals and then linking the individual IRRs with equal weighting.
    • More suitable for evaluating the performance of underlying assets and comparing different investment managers or benchmark indices.
    • Helps assess how well the manager performed with the money invested.

Bottom Line:

  • TWR is a better measure of how well the manager performed with the invested assets, as it eliminates the impact of cash flows.
  • IRR reflects the overall growth of the portfolio and is useful for assessing whether financial goals are being met.
  • Understanding these distinctions is crucial for making informed investment decisions and evaluating portfolio performance accurately.

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