Table of Contents
- Why Return Metrics Matter More Than You Think
- Total Return: Your Starting Point
- Simple Return: The Percentage Game
- Annualized Returns: Making Fair Comparisons
- Time-Weighted vs Money-Weighted Returns
- The Myth of Beating The Market
- Alpha: The Holy Grail of Active Investing
- Which Metrics Should You Track
- My Return Tracking Evolution
Why Return Metrics Matter More Than You Think
When I first started investing over a decade ago, I thought checking my account balance was enough to know if I was doing well. If the number went up, I was winning. If it went down, I was losing. Simple, right?
Boy, was I wrong.
I remember the day I discovered my "winning" year wasn't actually a win at all. Sure, my portfolio was up 15%, but the market had gained 25%. My active trading wasn't making me smarter than the market—it was making me poorer than if I'd just bought an index fund and gone to the beach.
Different return calculations tell you completely different stories about your performance. It's like watching a sports game from different camera angles—each perspective reveals something the others might miss.
Total Return: Your Starting Point
Let's start with the most straightforward metric: total return. This is simply asking "How many more dollars do I have now compared to when I started?"
What It Is
Total return measures your complete gain or loss, including both price changes and any income your investments generate (dividends, interest, distributions). It's the most honest answer to "How much money did I make?"
The Formula
Total Return ($) = Ending Value - Beginning Value + Distributions
Real-World Example
Last year, I invested $10,000 in an ETF:
- Initial investment: $10,000
- Current market value: $11,200
- Dividends received: $300
Total Return ($) = $11,200 - $10,000 + $300 = $1,500
My total return is $1,500. I'm $1,500 richer than when I started (before taxes, of course).
When to Use It
Total return is perfect when you want the raw dollar amount. It's what actually matters for your bank account, but it's terrible for comparing investments of different sizes or durations.
Simple Return: The Percentage Game
Simple return converts your dollar gain into a percentage, making it easier to compare different investments.
The Formula
Simple Return (%) = (Total Return / Beginning Value) × 100
Example Calculation
Using the same example:
Simple Return (%) = ($1,500 / $10,000) × 100 = 15%
My investment returned 15%. Now I can compare this to other investments, regardless of size.
The Limitation
Simple return doesn't consider how long it took to achieve that gain. A 15% return over six months is very different from 15% over three years!
Annualized Returns: Making Fair Comparisons
This is where things get interesting. Annualized returns answer the question: "What would my return be if this performance continued for exactly one year?"
The Formula (for periods over one year)
Annualized Return = [(Ending Value / Beginning Value)^(1/Number of Years)] - 1
Example Calculation
Let's say I held that ETF for 3 years:
Annualized Return = [($11,500 / $10,000)^(1/3)] - 1 = 4.77%
Suddenly, my seemingly impressive 15% total return becomes a more modest 4.77% per year. This is crucial for honest performance evaluation.
Why I Love This Metric
Annualized returns let me compare apples to apples. When a friend brags about their 30% gain, I always ask: "Over what time period?" A 30% gain over five years is actually just 5.4% annualized—less impressive than it sounds.
Time-Weighted vs Money-Weighted Returns
Here's where most investors get confused, including myself for years. These two metrics can tell radically different stories about the same portfolio.
Time-Weighted Return (TWR)
Think of TWR as measuring the performance of your investment strategy, independent of when and how much money you added or withdrew.
It answers: "How well did my investment choices perform?"
Money-Weighted Return (MWR)
MWR measures your actual experience as an investor, considering the timing and size of your contributions and withdrawals.
It answers: "How well did I do with my money?"
A Personal Example
In 2019, I had two very different experiences with the same fund:
- TWR: The fund returned 22% for the year
- MWR: My personal return was only 8%
Why the difference? I invested most of my money in November, after the fund had already gained most of its yearly return. The fund did great; my timing was terrible.
Which Should You Use?
- Use TWR to evaluate your investment selection skills
- Use MWR to understand your actual wealth building
- Professional managers report TWR because they don't control client deposits
- Individual investors should focus on MWR for personal planning
The Myth of Beating The Market
For years, I obsessed over "beating the market." Every financial publication talks about it, every fund manager claims they can do it, and every retail investor dreams about it.
But what does it actually mean?
Defining Your Benchmark
"The market" isn't a single thing. Which market?
- S&P 500 for U.S. large caps
- Russell 2000 for small caps
- MSCI World for global stocks
- Your local country's index
I learned this lesson the hard way when I celebrated "beating the market" by comparing my international stock picks to the S&P 500. Sure, I beat the U.S. market, but I underperformed the international index by 5%. I was comparing apples to oranges.
The Harsh Reality
After tracking my performance meticulously for over a decade, here's what I've found:
- Most years, I don't beat my benchmark after fees and taxes
- The years I do beat it rarely compensate for the years I don't
- The time spent trying to beat the market could've been used more productively
This realization led me to put most of my portfolio in index funds, keeping only a small portion for active investing (more for education and entertainment than serious wealth building).
Alpha: The Holy Grail of Active Investing
Alpha represents your excess return above what you'd expect given the risk you took. It's the true measure of whether your active management adds value.
Understanding Alpha
Think of it this way:
- Beta represents market risk and return
- Alpha represents your skill (or luck) in generating extra returns
The Formula (simplified)
Alpha = Portfolio Return - (Risk-free Rate + Beta × (Market Return - Risk-free Rate))
My Alpha Reality Check
In my early trading days, I thought I was generating massive alpha. Then I properly calculated it:
- My portfolio return: 18%
- Market return: 15%
- Risk-free rate: 2%
- My portfolio beta: 1.2
Expected Return = 2% + 1.2 × (15% - 2%) = 17.6%
Alpha = 18% - 17.6% = 0.4%
My seemingly impressive 3% outperformance was actually just 0.4% alpha after adjusting for the extra risk I was taking. Humbling.
Which Metrics Should You Track
After years of experimentation, here's my practical framework for which metrics to track based on your investing style:
For Passive Investors (Index Funds/ETFs)
- Total Return (quarterly)
- Annualized Return (yearly)
- Money-Weighted Return (yearly)
For Active Investors
- All of the above, plus:
- Time-Weighted Return (to evaluate strategy)
- Alpha (to justify the extra effort)
- Rolling 3-year returns (to spot trends)
For Traders
- Win rate and average win/loss ratio
- Monthly returns
- Maximum drawdown
- Sharpe ratio (we'll cover this in a future post)
My Return Tracking Evolution
Let me share how my approach to tracking returns has evolved over the years:
Phase 1: The Newbie (Years 1-3)
- Checked account balance daily
- Celebrated every gain, mourned every loss
- No systematic tracking
- No benchmark comparison
Phase 2: The Spreadsheet Warrior (Years 4-6)
- Built elaborate Excel sheets
- Tracked every metric possible
- Spent more time measuring than investing
- Analysis paralysis kicked in
Phase 3: The Pragmatist (Years 7-Present)
- Simple quarterly reviews
- Focus on money-weighted returns
- Compare to appropriate benchmarks
- Automate what I can
The key insight? Perfect tracking isn't the goal—understanding your true performance is. I now spend maybe an hour per quarter on performance measurement, and my results have never been better.
Putting It All Together
Return metrics aren't just academic exercises—they're practical tools that shape better investment decisions. Here's how I use them:
- Monthly: Quick total return check (5 minutes)
- Quarterly: Calculate simple and annualized returns (30 minutes)
- Yearly: Full analysis including TWR, MWR, and alpha (2 hours)
Remember, these metrics are tools, not goals. The purpose isn't to generate the highest possible return—it's to understand whether your investment strategy aligns with your life goals.
As I discussed in my investor profile comparison, your ideal return metrics depend on your risk tolerance and time horizon. A conservative investor shouldn't chase alpha, and an aggressive investor shouldn't panic over volatility.
The metrics that matter most are the ones that help you sleep at night while steadily building wealth. Everything else is just noise.
What return metrics do you track? Have you ever been surprised by the difference between your perceived and actual performance? Share your experience in the comments below.
Disclaimer: This content is for informational purposes only. I'm not a financial advisor. Trading & Investing involves risk of loss and you should consult with qualified professionals before making investment decisions.