Weighting Returns

SUPPOSE YOU BOUGHT a stock mutual fund five years ago and you still own it today. What return did you earn? If you go to the fund company’s website, it’s easy enough to find out the five-year total return. There’s a chance, however, that your personal performance was quite different from the fund’s published result.

The total return number will be a so-called time-weighted return, meaning it’s the return you would have earned if you bought the fund at the beginning of the period, and thereafter never sold any shares or invested further dollars. The published performance does, however, assume you reinvested all fund distributions in additional fund shares. We’re talking here about those income and capital gains distributions that are made periodically by funds for tax purposes, and which simply reflect the return of your own money.

Now, suppose that—instead of simply buying and holding the fund—you sold shares during the five years or added new money to the fund. This could make a big difference to your return. Let’s say the stock market dropped 30% in the middle of the five years and then bounced back, and you invested even more money in the fund in the midst of the market swoon. Because of your good timing, those additional dollars you invested would have notched handsome gains.

The upshot: To figure out how your fund investment performed over the five years, you’d need to calculate not a time-weighted return, but a dollar-weighted return. The calculation is complicated. But you may find that your mutual fund company or brokerage firm does the math for you. On your investment statements or on the company’s website, this figure is often labeled your “personal rate of return.”

Next: Gordon Equation

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