^{Building Wealth} Simple Rate of Returns or Time Weighted Returns

Understanding investment performance: Simple Rate of Return or Time-Weighted Return

When evaluating an investment’s success, two commonly used methods are the Simple Rate of Return (SRR) and the Time-Weighted Returns (TWR).

Simple Rate of Return (SRR)

The Simple Rate of Return provides a straightforward calculation of investment performance.

For example:

• You open a savings account with $1,000 and earn $50 in dividends over 12 months.
• Your return is 5%, to calculate the Simple Rate of Return (SRR):
  • Initial investment: $1,000
  • Earnings (dividends): $50
  • Formula:
    SRR = (Earnings ÷ Initial Investment) × 100
  • Calculation:
    SRR = ($50 ÷ $1,000) × 100 = 5%

While SRR is useful for basic calculations, it becomes less reliable when multiple deposits and withdrawals occur, as seen in this scenario:

• At the end of your first year, you receive an inheritance and deposit $100,000, bringing your total to $101,050.
• After another 12 months at a 5% return, your balance grows to $106,102.50.
• You withdraw $100,000, leaving you with $6,102.50 in your account.

Despite only contributing $1,000 personally, SRR incorrectly suggests a 510% return—a misleading result due to large external cash flows.

Time-Weighted Returns (TWR)

The Time-Weighted Returns provides a more accurate reflection of investment performance by:

• Breaking the investment period into smaller sub-periods
• Calculating the return for each sub-period separately
• Multiplying the sub-period returns together to remove distortions from external cash flows

Using TWR in the previous example, the return for each period remains 5% on annualized basis, smoothing out all the deposits and withdrawals leaves with a Time-Weighted Returns of 10.25% by the end of the two periods.

TWR is widely used in professional investment analysis because it provides a clear and unbiased measure of an investment’s performance over time. It serves as a financial diary, helping investors understand how their portfolio performed at different stages.

Simplified investment tracking

Calculating TWR was once complex and time-consuming. However, with our latest tool, you can now toggle between Time-Weighted Returns and Simple Rate of Return, giving you greater flexibility in analysing your investments.

To learn more about Time-Weighted Returns (TWR) and Simple Rate of Return (SRR), click here.

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