In what scenario do money-weighted and time-weighted rates of return differ significantly?

The scenario in which money-weighted and time-weighted rates of return differ significantly occurs when external cash flows are substantial relative to the account's value and there is volatility in investment returns.

The money-weighted rate of return (MWRR), also known as the internal rate of return (IRR), accounts for the timing and amount of cash flows into and out of the investment. This means that if there are significant cash flows, especially during volatile market periods, the MWRR can be heavily influenced by when those cash flows occur. For example, if a large amount of money is added to an account just before a market downturn, the MWRR will reflect the negative impact of those returns more intensely than the time-weighted rate of return (TWRR).

On the other hand, the time-weighted rate of return (TWRR) measures the compound growth of one unit of currency invested over a given period, removing the effects of cash flows. Therefore, it provides a purer measure of the investment performance attributable solely to the assets themselves, independent of when cash flows occur.

Thus, in scenarios where cash inflows or outflows are significant compared to the overall portfolio value, and the market displays volatility, the differences between