What are time-weighted returns?

When people look at their returns, one goal is to understand how well Betterment is managing their money. If you want to judge how well Betterment has built your portfolio, the time-weighted return (TWR) is one of the most useful figures to use.

When you log into your Betterment account from a web browser and go to the Performance section, at the top right you’ll see your time-weighted return. If you’re logged in on the mobile app, tap “See performance,” and your time-weighted return will be listed first. We list it first because we want you to see if first, because for most Betterment customers, it’s one of the most useful numbers to look at to compare to how ‘markets’ are doing.

Remember that time is one of the most important factors when investing, especially over the long run. The time-weighted return measures how much the underlying asset mix in the portfolio is returning over a given timeframe. Of all the possible returns figures, it is the most reflective of how well we’ve designed your portfolio. When comparing it to markets or others returns, ensure you’re doing it fairly by aligning risk levels, the timeframe you’re looking at, and whether or not you’ve made allocation changes along the way.

How Should I Think About the Time-Weighted Return?

Time weighted returns can be thought of as the change in value your investments would have experienced if all the dollars you ever deposited were invested at the same moment as your very first deposit. Put another way, the time-weighted return can be thought of as the simple earnings for just the first deposit ever into an investment account.

The time-weighted return takes deposits and withdrawals out of the equation when evaluating your portfolio performance, and therefore is unaffected by deposits to and withdrawals from your account. Why would you want to see a calculation that does this? Because cash coming in and out of your portfolio at different times can distort and complicate your returns due to the nature of the constantly fluctuating stock market. And if you were comparing returns across two different accounts with two different cash flow patterns, you couldn’t be sure if the difference was due to the investments or due to the timing of the cash flows.

Ruling out cash flows makes it easier to understand how well your portfolio is doing, and allows you to fairly compare your Betterment portfolio with other investments. The time-weighted return is the industry standard investment return to compare performance across various portfolios and indices. Common indices, such as the S&P 500, are reported using the time-weighted return.

Because this return calculation removes the effect of specific deposits and withdrawals, two investors that start investing at the same time in an 80% stock portfolio at Betterment will have nearly identical time-weighted returns, regardless of their deposit or withdrawal patterns. Small differences will exist, arising from slightly different portfolio weightings due to portfolio drift, but generally, the difference in the time-weighted returns at the same stock allocation in the Betterment portfolio will likely be minimal.

The Relationship Between Dollar Earnings and Time-Weighted Returns

While the time-weighted return can be useful for assessing how well your portfolio manager is managing your portfolio, it is not as helpful in understanding how many actual dollars you as an investor are making in earnings through your investments.

Positive earnings but negative time-weighted returns.

An investor could consistently happen to make deposits when the market is low, only for the value of those securities to increase later in the future. In such circumstances, it would be possible for the investor to have positive earnings, even if the overall time-weighted return was negative.

Suppose you invest $10 to start, and then the securities in your portfolio go down 50% in value. Now you have $5 in the account. You then make a $100,000 deposit and the value of your portfolio goes up 10% immediately after that. In this case, you would have positive dollar gains, since you just gained about $10,000—much more than your initial $5 loss. It was not because the portfolio has performed well—in fact, your time-weighted return has been negative overall since you started, because it went down 50% and then up 10%. However, most of your money was invested right before a rally so, because of the timing and size of your deposits, you happen to have positive earnings.

Negative earnings but positive time-weighted returns.

On the flip side, an investor could happen to consistently make deposits while the market is at a high, before the value of the securities drops in price when the market falls. That investor would have negative earnings in dollars even with an overall positive time-weighted return.

Suppose you invest $10 to start, and the market gains 50%. Now you have $15 in the account. You then make a $100,000 deposit and the market goes down 10% immediately after that. In this case, you would have negative dollar gains, since you just lost about $10,000—much more than your initial $5 gain. It was not because the portfolio has performed poorly thus far—in fact, your time-weighted return has been positive overall since you started, because it went up 50% and then down 10%. However, most of your money was invested just before a drop, and because of the timing and size of your deposits, you happen to have negative earnings.

Note that these are extreme cases meant to illustrate the differences between the time-weighted return and other types of returns you may be looking at as an investor.

If you have an investment account for which you, the investor, control the cash flows into and out of the portfolio, and you want to judge the performance of the portfolio without the timing and size of your cash flows, you would use the time-weighted return. Because this is the only return that takes cash flows out of the equation, it is the preferred method you should use to compare the performance of different investments against a benchmark. It’s the industry standard return methodology for financial advisors.