How to Calculate Money-weighted Returns

Let’s say we had the following investments and returns in the past 3 years:

In the first year, we made an investment of $1000, and we had a 100% return in the first year. By the end of the year, our investment has grown to $2000. Then at the beginning of the second year we invested $2000 more making a total investment of $4000. The returns in the second year were -50%, and our investment value reduced to $2000. Then assume we withdrew $500 from the investment fund, leaving only $1500 invested. In the third year there was no new investment, and our returns were 35%, making our investment grow to $2025. The cash flows are shown in the table below.

The money-weighted returns can be calculated using the same formula as that of the Internal rate of Return (IRR).

Our cash flows are as follows:

CF0 = -$1,000

CF1 = =$2,000

CF2 = +$500

CF4 = $2,025

Applying the above formula and solving for IRR we get:

IRR or money-weighted returns = -8%

This tells the investor about what she actually earned on the money invested for the entire three year period. Note that this return is negative because a significantly large amount of money was invested in the year of negative returns compared to other years.