Understanding Time-Weighted Return (“TWR”)

Time-Weighted Return (“TWR”) measures an investment’s performance by neutralizing the impact of cash flows, such as contributions and withdrawals. This approach ensures that TWR captures the core performance of the underlying assets by calculating returns across sub-periods without reflecting cash flow timing. TWR is often recommended for assessing the performance of an overall portfolio, especially in cases where cash flows vary due to client decisions or market timing.

By providing a consistent measure across varying time frames, TWR allows for a clearer view of how investments perform over time, unaffected by cash flow influences.

Internal Rate of Return (“IRR”) and Its Applications

The Internal Rate of Return (“IRR”) measures the growth rate of an investment, considering the timing and size of cash flows. This makes IRR particularly valuable when assessing the return on a single investment or a specific deal, where the timing and amount of cash flows are critical factors in measuring growth.

However, IRR may sometimes reflect the influence of cash flow events more than the underlying asset performance, which can be misleading in long-term assessments. For instance, significant deposits or withdrawals can create fluctuations in IRR that may not represent the portfolio’s core growth.

Balancing TWR and IRR for Comprehensive Reporting

At The Family Office, both TWR and IRR are used, depending on individual portfolio characteristics and financial goals. Here’s how each metric serves different purposes:

• TWR provides a consistent view of overall portfolio performance, ideal when client contributions or withdrawals vary over time. By focusing on asset performance alone, TWR allows clients to evaluate their investments unaffected by cash flow timing.

• IRR, in contrast, captures the impact of cash flow timing and size, reflecting growth in cases where specific investment decisions and cash flow patterns significantly influence performance. This makes IRR particularly useful for evaluating individual investments or specific deals.

Scenario Analysis: How to Use TWR and IRR

To illustrate the practical applications of TWR and IRR, consider three hypothetical scenarios:

• Scenario 1: A steady growth model where an initial investment doubles over time. Both TWR and IRR closely align, reflecting consistent portfolio growth.

• Scenario 2: An investment with periodic distributions, where TWR provides a stable view of asset performance while IRR reflects cash flow fluctuations.

• Scenario 3: A case with variable distributions where TWR remains stable, while IRR reflects the variability and timing of cash flows, demonstrating their impact on the overall return.

These examples demonstrate that TWR and IRR provide complementary insights, with TWR offering stability unaffected by cash flow timing and IRR capturing cash flow impacts.

Choosing the Right Metric for Your Financial Goals

In helping clients achieve long-term financial goals, The Family Office utilizes both TWR and IRR to ensure a comprehensive view of their portfolio performance. While TWR may be favored for its consistency over time, IRR also adds value when assessing specific deals or investments, where cash flow timing and size are crucial to understanding growth. By leveraging both metrics, The Family Office provides clients with a holistic perspective on how their investments perform.

Conclusion

Choosing the right metric to evaluate investment and portfolio performance can help investors make well-informed decisions. While IRR plays a crucial role in assessing the impact of individual cash flow events or specific investments, TWR provides a broader view of overall portfolio performance. For The Family Office’s clients, both metrics offer valuable insights, enabling effective tracking of investments and supporting confident, future-focused decisions.

To learn more about how TWR and IRR can enhance your understanding of your portfolio performance, connect with The Family Office for a personalized consultation on our approach to wealth management.

Disclaimer:

The results shown in the above case study, such as the potential doubling of a $100,000 investment, are hypothetical examples and are subject to market risks and fluctuations that may affect outcomes.

The scenarios shown assume specific cash flow patterns, reinvestment rates, and market conditions. These factors can vary in real-world situations, and deviations may significantly impact the returns.

Investments are subject to risk and volatility and returns like those in the scenarios provided also carry an associated level of risk. Positive returns shown here may not always align with real-world results, especially in volatile markets.

Past performance is not indicative of and does not guarantee future performance. Exit timelines, prices and related projections are estimates only, and exits could happen sooner or later than expected, or at a higher or lower valuation than expected, and are conditional, among other things, on certain assumptions and future performance relating to the financial and operational health of each business and macroeconomic conditions.