How to Measure Investment Performance
It’s hard not to wonder about how your investments perform, objectively. They may “seem good,” or things might “feel slow,” but a truly objective measure works better for peace of mind and future decision-making. For a wealth advisor in Denver, this is a common question. With the recent market volatility, this question comes up even more frequently.
Frequently, investors answer this question themselves using a simple rate of return, also referred to as a holding period return. However, these two other methods for measuring investment performance usually give more relevant answers. Let’s take a look at three options for measuring return rates, and in which situations they provide the most pertinent information.
Simple Rate of Return – Holding Period Return (HPR)
The most straightforward calculation to make, your cumulative return value doesn’t consider the amount of time it took to earn the return. A spectacular return in one year would be miserable over ten years. The HPR, whether you calculate it yourself or a wealth advisor in Denver calculates it for you, is reported as a simple percentage.
Internal Rate of Return (IRR)
To calculate the Internal Rate of return requires more data. However, it considers:
- Overall time period
- Timing of principal contributions or withdrawals
- Reinvestments of capital gains and dividends
As a general principle, when you control when you make your investments, IRR most effectively measures your investment returns. The return values report as compound annual values, not as cumulative, simple single return values.
Time-Weighted Return (TWR)
Time-Weighted Returns effectively evaluating specific investments, portfolios, or benchmark returns for comparisons. When your wealth advisor in Denver helps you analyze a specific investment, this method consistently gives meaningful values for your rate of return to compare fund performances.
The calculations are similar to the IRR; however, the TWR removes the timing details of additional contributions and withdrawals. So, the Time Weighted Return measures the pure performance of your underlying investments.
TWR measures the performance of your very first dollar ever invested and effectively compares two investment options when with uncontrolled cash flow timing. For just one contribution in an investment, the TWR and IRR are identical.
The TWR, however, does not effectively highlight the true performance levels of investments that require adjustments for your cash flow in and out of the portfolio. To earn specific rates of return over time and with various accounts, a wealth advisor in Denver can show you how to use IRR. That way, you can see if you meet your minimum return rates necessary to achieve your financial goals.
Ethical Standards
What may appear simple, the reporting on a rate of return, in fact, becomes a profound ethical responsibility. To even imply more or less return than the investment has serious ethical consequences. Your wealth advisor in Denver works diligently, with a fiduciary responsibility to report and compare your returns. You receive a reliable depiction of your portfolio, which generally includes both IRR and TWR periodically. In addition, you can always request a cumulative return report.
Ultimately, measuring your investment returns in a meaningful, relevant fashion gives you the information you need for your financial decision-making. Consult your wealth advisor in Denver for more information.
