Your balance is not your return

The balance rises when you add money

Open your account and the first number you see is the balance: what your portfolio is worth today. It is tempting to read it as a score. It is not one.

Suppose your balance went from $1,000 to $1,890. That looks like a gain of 89%. But if you deposited another $1,000 along the way, you put in $2,000 — and you are $110 down, not up.

Money you move in or out — a deposit or a withdrawal — is a cash flow. It changes the balance without being earned or lost by your investments. So the first rule of measuring is simple: profit is what the portfolio is worth, minus the money you put in, plus anything you took out.

A dividend paid into your account is different. It was earned by what you hold, so it is part of your return, not a deposit — your total return is price changes plus income.

Two investors, the same choices

Leyla and Rauf make the same choice: each puts $1,000 into the same fund on the same day. The fund then rises 10%, and later falls 10%. The only difference: Rauf deposits another $1,000 just after the rise, right before the fall.

Neither number is wrong. They answer two different questions, and you need a different measure for each.

Simple return: what happened to your money

The first question is: what happened to the money I put in? The simplest answer divides the profit by the money put in.

Leyla: −$10 ÷ $1,000 = −1%. Rauf: −$110 ÷ $2,000 = −5.5%.

This is honest and useful — it is what your money actually did. But it mixes two things: how your investments performed, and when and how much you happened to add. More careful versions also count how long each deposit was invested, but they share the same nature: your timing is part of the answer.

Time-weighted return: what your choices did

The second question is: how well did the investments I chose perform? To answer it, the deposits have to be taken out of the picture. That is what the time-weighted return does.

It works in three steps:

1. Cut the period at every deposit and withdrawal. Each piece is a stretch in which no money came in or went out.
2. Measure each stretch on its own — the value at its end divided by the value at its start, after the cash flow that opened it.
3. Chain the stretches by multiplying them.

Two things are worth seeing here. First, the deposit vanished from the answer: whether Rauf added $1,000 or $100,000, his time-weighted return is −1%. Second, the stretches are multiplied, not added. A 10% rise followed by a 10% fall is not zero: $100 becomes $110, then $99.

It works the other way, too. Had the fund fallen 10% first, and Rauf deposited before a 10% rise, he would have $900 + $1,000 = $1,900, growing to $2,090 — a profit of $90, or +4.5% on his $2,000. His time-weighted return would still be 0.90 × 1.10 − 1 = −1%. Lucky timing made money; the investment itself still lost 1%.

Compared with what?

A return on its own says little. +10% in a year when the whole market rose 17% is a different story from +10% in a year when it fell. You need a benchmark: a yardstick, usually an index, that resembles what you hold. For a portfolio of large US companies that is often the S&P 500; for one heavy in technology, perhaps the Nasdaq-100.

An index has no deposits or withdrawals, so its return is already a time-weighted one. That is why the time-weighted return is the fair number to set against it — like against like. Two more rules keep the comparison fair:

• The same days. From the same start date to the same end date. A benchmark measured over a different period means nothing.
• Percentage points. The gap between two returns is stated in percentage points. Your 10% against the index’s 17% is 7 percentage points behind — not “7% behind”.

In the figure, the example portfolio is up 10% — a good result on its own. Reveal the benchmark: over the same period it rose 17%, so the portfolio trailed it by 7 percentage points. Both statements are true; only the second tells you how the choices compared.

In short

Your balance rises when you deposit, so it is not your return. Profit is the value minus what you put in, plus what you took out. Simple return tells you what happened to your money, including the luck of your timing. Time-weighted return cuts the period at every deposit and withdrawal and chains the pieces, so it measures only what your investments did. Set that against a benchmark, over the same days, and read the gap in percentage points.