Three rates of return you should know: IRR, SRR and TWRMarch 27, 2015 12:00 am
For obvious reasons, everyone wants to know their rate of return—and rightfully so. Regardless of whether it’s a “do it yourself” investor or an experienced mutual fund manager, who doesn’t want to know how well they’re doing? In my line of work, its hands-down the most common question I get. Here’s a question for you, the reader: Do you know what type of rate of return you’re being quoted? Yes, there is more than one type. While there are quite a few, let’s stick to the three basics you’ll likely encounter.
IRR: Internal Rate of Return
Internal rate of return is how your overall portfolio performed and includes the size and timing of cash flows (withdrawals and/or deposits) to create a more personalized rate of return. This is what I like to call the “bottom line” return. This is an excellent measure of how you actually performed during a given period. At StrategicPoint we provide this in our reporting, and it is presented net of fees unless a client pays management fees from an outside account.
TWR: Time Weighted Return
Time weighted return, which StrategicPoint also provides, is how your advisor or portfolio manager performed. It removes the effects of cash flow into and out of a portfolio—something an advisor doesn’t have any control of. TWR is the type of return used more commonly to measure how your investment advisor performed.
SRR: Simple Rate of Return
Simple rate of return, as the name states, is the easiest of the three in terms of calculating. It’s the percentage change in market value. SRR is mostly used to calculate an index or benchmark. It doesn’t take into consideration any cash flows or time value of money. All three return rates mentioned here can be a separate number on the same portfolio within the same time frame because they each use a different formula for calculation.
Here is an example. Below are two different rates of return for the same portfolio.
Ending Balance of $1,163,032
TWR is 5.53%
IRR is 7.14%
The reason they are different is because cash was added to the portfolio, and IRR takes cash flow into consideration when calculating the rate of return. If the investor did not deposit or make any withdrawals, the IRR and TWR would both be 5.53%.
The IRR includes cash flow and timing, giving you a more complete picture of your performance. The TWR shows the return of how the manager performed (without cash flow) and timing. These two methods show you the difference between how your portfolio performed and how your manager performed. Hopefully this helps you be more prepared and informed the next time you ask “what’s my return?” And may your IRR be a positive one!
The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Sean’s opinions and comments expressed on this site are his own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.