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What is the difference between dollar weighted and time weighted return?

Within the Portfolio Director Home screen you may notice that there are two performance measures, Time-weighted and Dollar-weighted return. Though both are measuring the performance of the portfolio they measure slightly different things.

Click on the titles in Stock Doctor to get a full technical description of what each measures. This explanation tries to simplify the concepts.

Dollar weighted return (often referred to as the Internal Rate of Return)

This rate of return measures the performance of "money down." In that it will measure the dollar return of the portfolio in its totality. This however means that it is sensitive to deposits and withdrawals from the portfolio. This is because a percentage increase (eg 10%) will reflect a higher dollar weighted return when more money is invested.

Taking the 10% example, the dollar weighted return I receive if my portfolio goes up 10% is greater if I have a larger amount invested. Ie 10% of $700,000 invested is greater than 10% on $100,000.

To use an analogy, if you are playing three hands in blackjack, the first two hands you put $1 on and lose both bets. Yet for the last you place a $10 bet and you win. Though you have lost more times than you won, your dollar return would see you come out on top.

This is why it is often referred to as measuring your ability to time or position yourself in the market.

Time weighted return 

This rate of return measures the compounded growth rate of $1 over the period measured. The period is important because this figure calculates the time-weighted average of the assets in the portfolio irrespective of cash additions or withdrawals. This means a 10% increase is measuring the performance of the stocks selected irrespective of dollars invested and allows direct comparison with other assets as dollar weighted does not consider 'money down' as above.

Taking the 10% example, a time weighted return of 10% means I can compare that to someone elses portfolio or an index as it is calculated irrespective of the cash I have to invest or how I use my money. It is simply measuring my stock picking ability.

To use the blackjack analogy, if you are playing three hands in blackjack, this time, the first two hands you put $1 on and win both bets. Yet for the last you place a $10 bet and you lose. While overall you are losing dollars, you have picked more winners than losers, and can compare yourself to any other blackjack player in the world and measure your "two-out-of-three" or 66.7% performance against them.  

Because of the comparison benefits, time-weighted performance is used to compare your portfolios to benchmarks. So when you see a portfolio graph in Stock Doctor, it is reflecting time weighted performance. 

If you have any further queries on the differences between time and dollar weighted returns please contact our office on 1300 676 333 or support@lincolnindicators.com.au

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