After establishing clear investment goals and developing a long-term strategy for reaching them, the next priority for investors is measuring the portfolio’s ongoing performance. After all, the reason for investing is to watch your investments grow.
Understanding how your portfolio is measured – in terms of your rate of return (ROR) – and what that measurement is showing you (or what it’s not) can provide you with a more accurate lens. It will also allow for more in-depth conversations and in-the-know decisions around your financial future.
What is a rate of return?
Rates of return are the industry standard for measuring investment performance. It’s the net gain or loss of an investment during a specific period, represented as a percentage of the investment’s initial cost.
While there are many ways to measure an investment portfolio’s performance, the two most common are calculating the time-weighted and money-weighted rates of return. Each method serves a different purpose in defining success.
At its most basic, a time-weighted return shows the compounded ROR of your portfolio for a specific period (a business quarter or a full year, for example), regardless of any contributions or withdrawals (referred to as the “cash flow”).
Time-weighted returns can be helpful in comparing your portfolio to broad-based industry benchmarks or indexes. Ultimately, it answers the question: how is the portfolio manager performing?
In late 2021, Co-operators transitioned to using a money-weighted ROR calculation for clients. This method, which Canadian securities regulators will soon require all financial organizations to provide for investors, considers all contributions and withdrawals (cash flow) made during the period being measured. This is significant, because cash flow can have a major impact on a portfolio’s performance, as it relates to the rate of return.
Overall, a money-weighted return measures your personal ROR, answering the question: how is my portfolio performing, compared to my long-term goals?
How do the methods compare?
The following table shows a sample scenario, comparing a time-weighted return and a money-weighted return. Let’s say that Lillie, Ellis and Remy each invested $10,000 on December 31, 2019. Then, in the period between their initial investment and July 1, 2020, the market declined by 3%, before gaining 7% by December 31, 2020. Here’s how their respective investments would have performed:
|Investor transactions on July 1, 2020
||Contributed + $8,000
|Market value on July 1, 2020
|Market value on December 31, 2020
||Lillie’s decision to make an additional contribution (which captured an upturn in the market) led to a positive overall performance.
||Ellis’ decision to withdraw funds led to a negative impact on his personal ROR. By redeeming funds after a decline in the market, he had to sell his investments at a lower price.
||Remy made no cash-flow changes. As a result, both his time-weighted and money-weighted RORs remained the same.
We’re here for you
Along with helping you create an investment plan that’s geared toward your personal goals, we can answer any questions along the way – including those related to your rate of return and overall portfolio performance. Talk to us today!
If you have questions about your investments, please contact your Co-operators financial representative.
For more information, resources and financial-market news, visit Market View.
*In the province of Quebec, the authorized representatives are Financial Security Advisors who have been duly certified by the Autorité des marchés financiers.
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