Are You a Good Investor, or Do You Have a Good Investment? A Tale of Two Returns
In our previous post in this series, we explored the difference between arithmetic and geometric average returns, highlighting how the order of returns matters. Today, we take that concept a step further to resolve one of the most common—and often frustrating—contradictions in personal finance: the gap between how an investment performs and how your account actually performs.
Have you ever looked at your portfolio, seen that a fund you own is up 15% for the year, yet your own account value has barely budged? It’s a disorienting feeling that leads to confusing questions: "Is my fund manager doing a good job?" versus "Am I just terrible at timing my investments?" This creates an either/or dilemma that can lead to anxiety and poor decisions.
At S3, we believe in resolving these financial contradictions with Both/And Solutions. The answer isn’t to pick one question over the other. The answer is to have a clear, simple way to measure the performance of your investments and the real-world impact of your own financial behavior. This post will give you the sound framework to do just that.
The Same Fund, Two Very Different Stories
To understand this, let’s imagine two friends, Steady Sarah and Reactive Robert. Both decide to invest $12,000 into the exact same mutual fund, the "Constitutional Growth Fund," over the course of a year.
The fund has a volatile year. In the first six months, fears of a recession cause it to drop 20%. Then, in the second six months, the economy roars back, and the fund soars, finishing the year up 10% overall.
Here’s how our two investors fared:
- Steady Sarah embodies the trustworthy tortoise pace. She invests $1,000 on the first of every month, no matter what the headlines say. She buys some shares when the price is high, and she buys even more shares when the price is low.
- Reactive Robert is driven by emotion. He invests his first $6,000, but when the market drops, he panics and stops contributing. When he sees the fund roaring back, he gets a case of "fear of missing out" and throws his remaining $6,000 in near the year's high point.
At the end of the year, the "Constitutional Growth Fund" reports a solid 10% return. Yet, when Sarah and Robert check their statements, their personal results are dramatically different. Sarah is thrilled with her return, which is even higher than the fund's reported 10%. Robert is devastated to see he has actually lost money.
How is this possible? They were in the same "good" investment. The difference lies in two distinct ways of measuring returns.
The Investment's Report Card: Time-Weighted Return (TWR)
The Time-Weighted Return (TWR) is the number you typically see in a fund's prospectus or a Morningstar report. Think of this as the "pure" performance of the investment itself, completely ignoring the investor's actions. It answers the question: "How did the fund manager or the underlying assets perform?"
The TWR calculation neutralizes the effect of cash flows (your contributions and withdrawals) to provide a clean, apples-to-apples comparison between different investments. In our story, the "Constitutional Growth Fund" did its job. Its 10% TWR is its official report card, and it’s a good grade. This is a sound, time-tested metric for evaluating an investment strategy on its own merits.
Your Personal Report Card: Dollar-Weighted Return (IRR)
The Dollar-Weighted Return (DWR), often called the Internal Rate of Return (IRR), is your actual, personal result. It answers the question: "How did my money actually do?"
This calculation is profoundly personal because it is heavily influenced by the timing and size of your contributions and withdrawals. It doesn't just measure the investment; it measures your experience with the investment.
- Sarah’s DWR was excellent because her steady, disciplined contributions meant she bought more shares when they were cheap, amplifying her returns when the fund recovered.
- Robert’s DWR was poor because his emotional decisions caused him to buy high and "sell low" (by not buying at all during the dip), sabotaging the fund's good performance.
As a Chartered Financial Consultant (ChFC®), this number is one of the most important diagnostic tools I have. It goes beyond just picking good investments and steps into the realm of financial coaching, where we can see how behavior is shaping your financial reality.
Understanding the 'Behavior Gap': The Story in the Numbers
The difference between the TWR (the investment's return) and your DWR (your personal return) is often called the "behavior gap." This isn't a grade to feel bad about; it’s a powerful piece of information presented without judgment. It is a tool for understanding and empowerment.
If your DWR is lower than the TWR of your investments, it suggests your timing decisions—perhaps driven by fear or greed—are detracting from your potential returns. If it’s higher, it means your timing (like Sarah's disciplined buying during the dip) has added value. For most people, a negative gap is unfortunately common.
A Both/And Solution: From Judgment to Insight
This brings us back to our constitutional approach. The traditional, anxiety-inducing question is, "Am I good or bad at this?" The constitutional, S3 approach is to use a Both/And Solution to gain clarity.
You can measure your fund's performance objectively (Time-Weighted) AND evaluate the real-world impact of your own financial behavior (Dollar-Weighted).
This insight is the first step toward building constitutional confidence. Instead of abandoning a sound investment (a high TWR fund) because of a disappointing personal result (a low DWR), we can focus on the real issue: creating a financial plan and a behavioral framework that helps close that gap. This is the heart of what we do—designing simple, sustainable systems that make wise behavior easier and emotional mistakes harder. It’s a partnership focused on aligning your actions with your long-term goals.
This human-centric approach serves all stakeholders. It empowers readers and prospects with a new way to think, deepens the collaborative partnership with clients, and fosters a more mature conversation about performance in our community—one that includes the vital role of personal accountability.
Building a Plan for Both Returns
Understanding the difference between these two returns allows you to move from being a passenger in your financial life to being a co-pilot. You learn to assess your tools (the investments) and your skill in using them (your behavior) separately but in synthesis. A sound financial plan isn’t just about having good investments; it’s about having a good process for investing.
Many brokerage statements show both of these numbers. Find them. Is your personal (dollar-weighted) return higher or lower than your investment (time-weighted) return? What story does that tell? If you want to build a plan that makes wise financial behavior simpler, schedule a clarity call.
This post is part of our Investments True Return Series.
DISCLAIMER: This content is for educational purposes only and should not be considered personalized financial advice. Always consult with a qualified financial professional before making financial decisions.