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Time-Weighted vs Dollar-Weighted Return

Course: Investment Planning
Lesson 14: Evaluating Portfolio Performance

Student Question:

For both the Treynor and Sharpe, part of the calculation involves using the average portfolio return (rp). In most examples, the average portfolio return is being given. However, if I need to calculate this in real life, do I use the dollar-weighted return (internal rate of return) or the time-weighted return (geometric mean)?

Thank you.

Sarah


Instructor Response:

Great question Sarah. If we’re evaluating the portfolio manager’s performance, we’d use the time-weighted return. If we’re evaluating an individual investor’s return, we’d use the dollar-weighted return. CFP Board has traditionally given the average return in risk-adjusted return questions, but if you are called upon to calculate average return, look for clues in the fact pattern to indicate which averaging convention to use.

Onward and Upward,

Bruce