Returns are important — and not just to people who are really bad at buying the right size clothes. Returns — or gains — on investments are the only reason that anyone invests. But there isn’t one universal way to measure returns.
Time-weighted returns are by far the most popular — the Coca Cola of measurements and the one you probably intuitively follow. Time-weighted returns simply show you the performance of a fund regardless of inflows or outflows of money into an account (a fancy financial speak way of saying account additions and subtractions). Time-weighted rate of returns are the primary way that you’re able to judge the performance of an asset manager, since an asset manager has absolutely no control over when you add or subtract money from your account.
Money-weighted returns, on the other hand, are a more accurate measure of how an asset’s rises and falls actually affect you and your investment. In the scary-looking equation used to calculate money-weighted returns, more weight is put upon returns of an asset when you have more money invested, and less when you have less invested. So for an example, if you’re invested in a fund that is stagnant for six months, then goes up 10% in the final six months of the year, your fund manager will show a better than respectable overall 10% time-weighted return for the year. But if you have $50,000 in the account for the first six months of the year, but take out half of it to buy a state of the art wine chiller before the year’s half over, your money-weighted return will be considerably lower, since you had only $25,000 in the account when it rose.