What does the time-weighted rate of return measure?

The time-weighted rate of return measures the compound growth rate of one unit of money invested over time. This metric is specifically designed to show how the investment's performance would have been if no additional capital had been added or withdrawn during the measurement period.

The time-weighted rate of return effectively isolates the performance of the investment manager by neutralizing the effects of cash flows (inflows and outflows), which can distort performance results. By focusing on the growth of a single unit of capital, it allows for a fair comparison between different managers and investments, making it a preferred metric for evaluating investment performance over multiple periods, regardless of the timing or size of contributions and withdrawals.

In contrast, other options like measuring the total inflow and outflow of cash or averaging returns across accounts do not capture the inherent growth potential of the investment itself, while understanding the impact of market volatility is important, it is not the fundamental purpose of the time-weighted rate of return.