POST OF THE DAY
IV Value Central
Tracking Portfolio Returns

Related Links
Discussion Boards

By TMFValuemoosie
January 6, 2010

Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light. How are these posts selected? Click here to find out and nominate a post yourself!

[This post is from our subscription newsletter Inside Value. Click here to take a free, no-risk thirty-day trial.] 

Hi Fools,

Quick, before the market opens tomorrow, write down the full mark-to-market value of your portfolio. Cash in the brokerage account, stocks, options, everything.

This will prepare you to measure using TWRR (Time Weighted Rate of Return) for the coming year.

Backtracking a bit, this is the time of year many of us sit by the fire and try to figure out how we did. Which quickly begs the question "compared to what?"

Well, "the market" right? Many of us on this board pick our own stocks for investment. We do this because of the belief that we can do better than some alternative. Whatever the reasonable alternative is for you (choose your index), if you regularly fail to beat it, then perhaps you should just invest in that index through whatever vehicle is available (fund, tracking ETF, etc.)

Measuring returns against an index isn't always as straightforward as it seems, especially if you have cash flows into or out of the account during the year. Many people use some form of IRR (XIRR in Excel), which skews returns based on the timing of cash flows. (XIRR is identical to a simple CAGR [compound annual growth rate] in the absence of cash flows, by the way).

XIRR (or CAGR) is appropriate for single stock lots. You bought this stock, and doubled your money in six months. That's better than a double that took seven years, and you rightly want that return calculation to show it.

Measuring the portfolio as a whole is a different story, especially if we want to a) make valid comparison to indices and funds, and b) isolate our raw investing acumen.

Consider twin brothers. They follow the exact same strategy, same companies, same timing of buys/sells, and same percent of portfolio allocated to each idea, and to cash. They should have identical returns, right?

If we measure using TWRR they will. If we use something dollar-weighted like XIRR, their returns will vary depending on the timing of any deposits and withdrawals to the account. So, one brother gets paid biweekly and sends part of his income to his 401k. The other brother chooses to max out his 401k in January from his year-end bonus. While dollar return may differ, this doesn't make one of them a better investor. We need to ignore the timing of cash flows to isolate performance. Think of the question being answered as: "how well would I have done with a fixed amount of money (doesn't matter how much) at the beginning of the year, and no deposits or withdrawals?"

Gather the data
To calculate TWRR, you need to capture the full value of your portfolio (including cash) a) at any significant milestone such as monthly, or at the very least year-end, and b) after the close of any day on which you deposit or withdraw cash.

That's why this is a good new-year plan. You probably don't have that data for last year. But you can track going forward, and have a full 2010 performance record (and beyond).

TWRR tools
The formula is described nicely on this website (http://www.dailyvest.com/Products/prod_calcmethods.aspx)

Look at the section titled "Time-Weighted Rate of Return - Daily Valuation".

I've implemented that logic in a sample Excel spreadsheet: http://www.mediafire.com/file/w0jvmtzjgrh/TWRR.xls

The first tab in the workbook is a comparison of TWRR and XIRR. By varying the cash flows you can see how the results diverge. XIRR will show "too low" returns during periods of heavy deposits, and "too high" returns during periods of heavy withdrawals.

The second tab is a template TWRR tracker that you can use for your own portfolio.

Note: TWRR on it's own is not an annualized or compounded number. It's counter-intuitive because "Time" is in the name, but it's completely agnostic to time. It's goal is to normalize-away the effects of time.

As such, the TWRR on the second tab is fine for one year's tracking. If you use this over time and want to show the compounding of the TWRR return, refer to the sample formula on the first tab under the header 'CAGR TWR'.

Here's to everyone beating their chosen index hurdle in 2010 and beyond!

Cheers,
-joe
Coverage Fool