PortHow to Calculate Your Portfolio's Rate of Return Accurately
The most popular way to calculate portfolio performance is also the most misleading. Here's why, and what to do instead.
Why simple subtraction fails
"I have 57,000 PLN, I deposited 50,000 PLN, so I earned 14%" only works if you deposited all your money on one day and never withdrew anything. In practice, people contribute monthly, sometimes withdraw funds, and each of these amounts has been invested for a different duration.
The effect is predictable: with regular contributions, this method systematically underestimates returns because fresh money hasn't had time to earn yet, but it already inflates the denominator.
XIRR — how much you've earned
Internal Rate of Return (IRR) considers the dates and amounts of all contributions and withdrawals. It calculates the annual rate at which all cash flows, discounted to today, equal the current portfolio value.
The result is a single number comparable to a savings account interest rate. It's the most accurate answer to the question, "How much have I truly earned on my money?"
TWR — How good was your strategy?
Time-Weighted Return (TWR) divides the portfolio's history into periods between cash flows and multiplies their returns. The timing of contributions becomes irrelevant, so it measures the investments themselves, not the luck of when you added funds.
This metric is suitable for comparison with an index — an index also doesn't receive contributions. If your TWR is lower than the WIG or S&P 500, that's information worth taking seriously.
What not to forget
- Commissions and spreads — with frequent trading, these can eat up most of your returns.
- Taxes — nineteen percent of profits is a real part of the equation.
- Currency — a position in dollars can gain, while the same position in your own currency can lose.
- Inflation — a return lower than inflation is a real loss, despite a positive number.
Frequently Asked Questions
What's the difference between XIRR and TWR?
XIRR tells you how much you've earned based on your specific deposit dates. TWR tells you how much the strategy itself has earned, regardless of when you made contributions. TWR is used for comparison with an index.
How to calculate returns in a spreadsheet?
The XIRR function takes a list of cash flows with dates: deposits as negative values, and the current portfolio value as a positive value on today's date. Keeping this list updated is the labor-intensive part, not the formula itself.
Is a positive return a good return?
Not necessarily. Returns must be considered in relation to inflation and the broader market. A return of plus 4% with inflation at 6% and the index up 18% is a poor result.
Related
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Portevo is not an investment advisor. The data and analyses are for informational and educational purposes only and do not constitute a recommendation or an offer to buy or sell financial instruments. Quotes are from external providers and may be delayed. You make investment decisions at your own risk.
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