Wealth Management Approach

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We'd like to talk to you about some changes coming on how your investment returns are reported. You'll be getting a new annual performance report in January 2017. It's a more personal way to see how your investments are doing. This new report is part of an industry-wide initiative called Phase 2 of the Client Relationship Model, or CRM2. It's a long title that comes down to greater transparency for investors.

One difference you will see in the new report is a personal rate of return. The personal rate of return will take into account of the contributions and withdrawals you make to your investment account. So it measures your personal performance. And that means the rate of return on this new report will be specific to you.

Your existing account statement shows how your portfolio is performing using a standard formula that most of the financial industry has used for years. It's called the time weighted rate of return. It is a useful measure in that it allows you to compare the performance of your investments to other investments over a period of time, and is not affected by personal contributions or withdrawals to your account.

The new report uses a different return calculation called a money weighted rate of return. Unlike the time-weighted rate of return, it includes the effect that the timing and amount of your contributions and withdrawals have on your investment returns, giving you a more personalized view of your investment portfolio.

It's important to note that time-weighted and money-weighted rates of return are both valid measures of investment performance. Time-weighted is most helpful when comparing different investment alternatives. Money-weighted provides a snapshot of an individual's return, reflecting their actual investment experience.

So let's dig a little deeper into how the two ways of calculating returns work. Let's say that you invest $100,000 in the portfolio on January 1. That's your only investment for the year. By December 31, your $100,000 has grown by 6% to $106,000. So your time-weighted rate of return for the year is a gain of $6,000 divided by your investment, $100,000, or 6%. Since you didn't touch your portfolio since your initial $100,000 investment, 6% is also your money-weighted rate of return. There is no difference between money-weighted rate of return and time-weighted rate of return in this case.

Now let's look at a second situation where you still invest your $100,000 at the start of the year, but you also invest an additional $100,000 at midyear. At the end of the year, your portfolio is now worth $209,921. Because your time-weighted return doesn't factor in your second contribution of $100,000, it is still 6%.

But here's something interesting. You had $100,000 in the account during the first half of the year plus the gains that were building up. So just before you made your second contribution, your portfolio was worth $102,000. When you added $100,000 to that, your total holdings were worth $202,000. So after your contribution, you had $202,000 invested in your account.

In the money-weighted calculation, the second half of the year would carry more weight because there is more money being affected by the portfolio's performance in the second half of the year. As it happens, over the second half, the portfolio had a stronger performance. It was up by an additional 3.9%. This difference is taken into account in the money-weighted rate of return calculation. So your money-weighted rate of return is 6.63%.

So let's sum up. There are two primary and valid measures of investment performance. In January 2017, you'll be receiving a new annual report that will show your personal rate of return using a money-weighted rate of return calculation. It will show the performance of your investments and the impact of your cash flow decisions. Thanks for watching.

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