Thursday, August 16, 2012

Personal rates of return ... what are they, really?

I am home this week, working on my doctoral dissertation proposal, and need references to cite for a "personal rate of return."

And so, like any good researcher, I began with a "Google search," and found the "Finance guy's" blog, which has a post on this subject.  He references an earlier one, where he advocates using the Original Dietz, across the full year, rather than the XIRR. While it's true that it can provide roughly the same result, the industry has pretty much abandoned this mid-point method. Okay, if your readers are truly unsophisticated investors, with limited math skills, perhaps this is okay, but I would couch such a formula with an explanation that its accuracy is not very good.

In the more recent post he has the following:

The personal rate of return you get from a financial service provider like Fidelity or Schwab is usually a Time Weighted Rate of Return. If you want a Dollar Weighted Rate of Return, you will have to do it yourself.

A "time-weighted rate of return" as a "personal" rate of return? What is personal about a time-weighted return? Ten people are invested in the same fund, but contribute different amounts during the year. What will their "personal rate of return" be under time-weighting? The same as the fund's performance, because by definition, we've eliminated the impact of the cash flows.

He cites another website, dailyVest, whose post on this subject states

Time-weighted rates of return can be calculated on a daily basis (one method known as Daily Valuation) or on a slightly less accurate monthly basis (known as Modified Dietz) where inflows/outflows are averaged for the month. This time-weighted methodology used for calculation of personal rate of return provides a truer measurement of how investments are performing.

No, no, no! A "personal rate of return" has to be "personal," does it not? And how do we get this? By taking the flows into consideration.

Perhaps we have a bit of Clinton-like speech here (as in, "it depends on what you mean by the word, is"), at least in dailyVest's case, because one might ask what "This" means, in "This time-weighted methodology." If they're referring to Modified Dietz, then they get partial credit. However, by linking the intraperiod Modified Dietz-derived returns, we achieve an approximation to a time-weighted return, which is not a money-weighted method.

The site "All Financial Matters" gets it right, because this author cites the XIRR as the formula to use. In his post he provides an example of an investor putting money into the Vanguard S&P 500 Index Fund (VFNIX), and states:

Some simple math will tell us that VFNIX returned 6.8% (not including dividends) from 1/31 – 12/31 ((111.64 – 104.54) ÷ 104.54). However, the real question is: how did the portfolio perform for you? Or, what was your personal rate of return?

Given that the investor made contributions during the year, he correctly references the XIRR (i.e., a money-weighted method) to obtain the personal rate of return.

Speaking of Vanguard, they have a brief video that describes the personal rate of return.

Time-weighting offers nothing personal to the investor.We need a money-weighted formula for that, be it (an unlinked) Modified Dietz, as a proxy for the true, exact, money-weighted return, or the internal rate of return. If there are no flows, then the TWRR equals the MWRR.

There is nothing "personal" about time-weighted methods. If you want a "personal rate of return," use an MWRR formula.


  1. You could possibly approach this notion with UAPS in mind. Because UAPS is intended to cover existing clients, a statement of (Full) disclosure could inform the client of the return the fund manager has achieved (Gross, TWR) and also include the return the client has acheived (Gross/Net) MWR. The sub text would reference the difference relating to TWR as the initial dollar invested, Vs MWR as the average dollar invested, and a brief description of why we are making the distinction. As I understand it, the UAPS white paper only mentions the TWR when dealing with existing clients, and could be the ideal opportunity to recognise the distinction.

  2. Please ignore my previous comment - I was looking under the "Best practies for Performance Calculation" section and did not read the whole section dedicated to reporting for exisitng clients before getting excited and posting the comment regarding MWR. "Broadly speaking, we encourage advisors to include a clear explanation of how the returns are calculated and what they mean to the client in any performance report they share with a client." - This broadly matches the avenue I was going down.

  3. Paul, thanks for your comment; your earlier comment wasn't posted, since you sent this one. I agree that such clarity is important; thanks!

  4. Paul, thanks for your note. It actually deals with both TWRR and MWRR for existing clients, as each tells a different story. All reporting to existing clients should arguably have both, except in cases where there is no manager with legal discretion, in which case MWRR is probably fine by itself.


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