Chances are, in your investment experience, you've come across the terms Internal Rate of Return (IRR) and Time-Weighted Return (TWR). You know they have something to do with how your investments perform—but what do these terms actually mean? And why is TWR especially important from an investor’s perspective?
Sit back, relax, and let me take you on a car ride.
🚗 The Road Trip: Understanding IRR
Imagine you’re heading out on a road trip. You jump in the car, stop for snacks and gas, hit traffic when you get to Atlanta, then stop to eat before finishing the final two-hour leg of your journey. At the end, you check your dashboard and see your average speed for the whole trip.
This is what it’s like when you measure your IRR—it takes all of your stops (your money going in and out) into account. It shows how well you personally did on your investment journey, considering your timing decisions along the way.
🏎️ The Racecar: Understanding TWR
Now imagine you’re a racecar driver.
You’ve been hired, along with other professional drivers, to test the latest Ferrari model. You all drive laps on a test track to measure the car’s average top speed. At the end, the engineers evaluate the car’s performance—not yours.
This is what it’s like to measure TWR—it reflects how well the investment itself performed, regardless of who was behind the wheel or when money was added or withdrawn.
| Feature | Internal Rate of Return (IRR) | Time-Weighted Return (TWR) |
| What it measures | Your personal investment success | The investment's inherent performance |
| Impact of cash flows | Included (deposits/withdrawals) | Excluded |
| Focus | Investor's timing decisions | Asset's performance over time |
🧭 So Which One Matters More?
If you want to know how you did with the timing of your deposits and withdrawals, take the road trip—IRR is for you.
If you want to know how the investment performed on its own, regardless of your actions, get in the racecar—TWR is your metric.
🎯 Final Thoughts
In the end, both IRR and TWR are useful tools when measuring investment performance. It just depends on the question you're asking:
Do you want to know how well you performed—or how well your car performed?