How to Calculate Your Personal Rate of Return

Personal rate of return is primarily calculated using two methods; dollar weight return or time-weighted return. A dollar-weighted return provides you with your personal rate of return. In contrast, a time-weight return provides a rate of return for a specific period, which is usually better a better method to use if someone is managing investment for you.

A basic understanding of calculating your investment return is valuable to assess how well your investments are doing. Today, most investment accounts and advisors have in-house software to do this for you without actually doing the calculation.

Therefore, the aim of this blog post isn’t to turn you into an investment return calculation specialist; instead, it’s to provide you with insight into the process.

How to Calculate your Investment Return with no Cash Flows

Before we move forward, all these calculations are based on a portfolio return. Some of these calculations can also be applied if you are looking for specific returns on an individual stock.

The most straightforward portfolio return to calculate is one with no cash flow. The term cash flow means the portfolio has no contributions or withdrawals during the holding period. It’s the easiest one to calculate because you take the portfolio’s market ending value and the portfolio’s starting value to determine the return rate. The exact formula is below;

Case Example

Let’s assume you have a portfolio with an initial investment value of $1,000 at the start of January 1, and by December 31, the investment had grown to $1,500. Using the formula above, your portfolio investment rate of return for the year was 50%. Since there were no additional contributions or withdrawals during the year, it’s a pretty straightforward calculation that tells you how your investment did. However, what if you did have cash contributions or withdrawals during the year? How do you calculate that rate of return?

How to Calculate your Investment Return with Contributions and Withdrawal

To calculate your portfolio return that has cash flow (contributions and withdrawals) we can use a similar formula but you will need to account for your withdrawing and contribution of money into the portfolio. The updated formula will look as such below.

A couple of things I should make you aware of regarding the formula. First, it assumes all your contributions will be made before the beginning while it assumes that all withdrawals are made just before the ending balance of the portfolio.

Case Example:

If we continue with the previous example of a starting investment of $1,000 as of January 1. Now, let’s assume you contributed another $500 say March 1, while withdrawing $200 as of November 1. The ending value still remains at $1500. Based on this contribution and withdrawals the portfolio’s rate of return will be 53%. The key with this formula is it’s more accurate compared to the previous formula as it takes into consideration the contributions and withdrawals made. However, it’s not the best option for getting your personal rate of return as it assumes you made contributions at the beginning and withdrawals just before the end of the period but this isn’t always the case.

How to Calculate Your Personal Rate of Return

Dollar-weight return is the best way to determine your personal rate of return on your investment return. There are three main reasons why this formula is better than using the previous formula already discussed. Dollar-weighted returns take into consideration how well the investment performs along with the amount and the timing of your contributions or withdrawals.

In doing so, the rate of return you get provides you with a more accurate return rate that reflects the impact your contributions and withdrawals have on your investment performance. The same portfolio with the exact same contributions and withdrawals but done at different times in the year may have a different rate of return depending on when those contributions were made.

If you wish to evaluate the performance of your investment without the cash flow, then you may use a time-weight return calculation.

Both these formulas can be a little complex and therefore, I’ve opted not to show them as it’s likely not to bring much value as realistically you will not be manually calculating your dollar-weight return.

The key takeaway is that when calculating your personal rate of return you need to use a formula that will take into consideration the contributions and withdrawals made into the account. It also needs to track the timing of these contributions for the period you are evaluating the return.

Dollar-Weight Return vs Time-Weighted Return: Which is Better?

You should use a dollar-weight return (internal rate of return) calculation when determining your personal rate of return on your investment. The reason for this is the formula takes into account the investment’s performance including the withdrawals and contributions made and when those occur during the return period.

As such, when presented with an investment return by anyone in which you have monthly contributions or withdrawals occurring, you should ask them for the dollar-weight return.

Today, most banks have been mandated to provide this information to you. Therefore, you should see your personal rate of return (dollar-weighted return) on your investment statement and you don’t personally have to calculate it yourself as long as the manner in which the investment firm or brokerage gets your rate of return is by using the dollar-weight return formula.

You should avoid being provided with a time-weight rate of return as your personal rate of return. Investment companies like to present their time-weight return to clients as it is essentially the portfolio return with cash flow. This formula excludes the cash flow and simply takes the ending value subtracted from the beginning value to get the rate of return. I’m simplifying the concept but it’s advantageous to the investment firm as the rate of return is likely to be higher than the personal rate of return you might get.

If you have an investment portfolio ensure your get your personal rate of return and ensure the manner in which it’s being calculated factors in your cash flow and timing of those cash flow while avoiding time-weighted returns presented by investment companies.