Money-weighted rate of return measures investment performance based on the amount of money in an account. It can be calculated by setting inflows against outflows, but is affected by the amount of funds in an account, which can skew results.
The money-weighted rate of return is a method of measuring the performance of an investment or an entire investment portfolio. It is called that because it is based on the amount of money in an account. To calculate the money-weighted rate of return, the inflows into an account are set up on one side of an equation against the outflows from the account on the other side. Whatever factor is needed to make the two parts equal is the rate of return on investment.
It’s crucial for investors to know how well their various investments are doing so they know if they need to make any adjustments. This may be simple enough when considering a single investment, but it can become increasingly difficult when considering all the investments that make up an entire portfolio. Fortunately, there are some mathematical calculations available to help you, such as the weighted rate of return on money.
To calculate the money-weighted rate of return, investors must set the inflows, or income to the investor, on one side of an equation against the outflows, or money leaving the investor’s account. For a simple example, imagine that an investor buys a stock for $50 US dollars (USD) and then sells it for $75 dollars. The output would be the purchase of $50 USD, and the input would be the sale price of $75 USD. Since the $75 is 1.5 times more than the $50 USD, it means that the weighted rate of return is 50 percent.
Of course, the investments that make up an entire portfolio can complicate the process to some degree. When evaluating the money-weighted rate of return for a portfolio, the outputs would not only include money used to purchase a security, but also any reinvested interest or dividend payments, as well as withdrawals from the account. Rather, entries would include proceeds from the sale of securities, interest or dividend payments left in the account, and contributions to the account.
Although it can be a clear indicator of investment performance, the money-weighted rate of return has one major drawback. As the name implies, performance is affected by how much money is actually in an account. Since this is the case, the performance will always look a bit better if there are a lot of funds in an account, which means that the results can be somewhat skewed.
Smart Asset.
Protect your devices with Threat Protection by NordVPN
