What is Money-Weighted Rate Of Return?

1707 reads · Last updated: December 5, 2024

The money-weighted rate of return (MWRR) is a measure of the performance of an investment. The MWRR is calculated by finding the rate of return that will set the present values (PV) of all cash flows equal to the value of the initial investment.The MWRR is equivalent to the internal rate of return (IRR). MWRR can be compared with the time-weighted return (TWR), which removes the effects of cash in- and outflows.

Definition

The Money-Weighted Rate of Return (MWRR) is a metric used to measure investment performance. It is calculated by finding a rate of return that equates the present value (PV) of all cash flows to the initial investment value. MWRR is essentially equivalent to the Internal Rate of Return (IRR).

Origin

The concept of the Money-Weighted Rate of Return originates from the Internal Rate of Return (IRR) in finance, which was introduced in the early 20th century to evaluate the profitability of investment projects. As portfolio management became more complex, MWRR was widely adopted to assess the overall performance of investment portfolios.

Categories and Features

MWRR is primarily used to evaluate the overall performance of an investment portfolio, especially when there are cash inflows and outflows. Its characteristic is that it considers cash flows during the investment period, thus providing a more accurate reflection of the investor's actual returns. Unlike the Time-Weighted Rate of Return (TWR), MWRR is affected by cash flows, making it more suitable for assessing individual investor performance.

Case Studies

Case Study 1: Suppose an investor makes multiple investments and redemptions in a fund over a year, resulting in an MWRR of 8%. This means that considering all cash flows, the investor's annualized return is 8%. Case Study 2: A company invests in multiple projects at different times, and by calculating the MWRR, it finds that the annualized return of its overall investment portfolio is 10%, helping the company evaluate the effectiveness of its investment strategy.

Common Issues

Common issues investors face when using MWRR include handling irregular cash flows and interpreting the differences between MWRR and TWR. Generally, MWRR is more suitable for evaluating individual investor performance, while TWR is better for assessing fund manager performance, as the latter eliminates the impact of cash flows.

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