Dollar-Weighted Return (IRR)
Definition
A portfolio return measure that accounts for the timing and size of cash flows (deposits and withdrawals), reflecting the actual return experienced by the investor.
Dollar-weighted return, also called Internal Rate of Return (IRR) or money-weighted return, measures your personal investment experience including when you added or removed money. It differs from time-weighted return, which measures the investment's performance regardless of cash flows.
The distinction matters because a fund can return 10% while you earn less if you invested most of your money right before a decline. If you put $10,000 in at the start of the year, the fund drops 20%, and then you add $50,000, even if the fund recovers to flat for the year, your dollar-weighted return is negative because most of your money experienced only the decline.
Dollar-weighted return is the more relevant metric for evaluating your personal financial outcomes. It answers "how did I actually do?" rather than "how did the investment do?" The difference between these can be significant for investors who add money during peaks and pull money during dips.
Research consistently shows that the average investor's dollar-weighted returns are significantly lower than the time-weighted returns of the funds they invest in. Dalbar studies show a persistent "behavior gap" where investor returns lag fund returns by 2-4% annually, primarily due to poor timing of buys and sells.
Portfolio tracking tools that calculate dollar-weighted returns give you the most honest picture of your investment performance. If your dollar-weighted return consistently lags the investment's return, it's a signal to automate your contributions and avoid timing decisions.
Where this appears in Clarity
Clarity automatically tracks and calculates these concepts across your connected accounts.
Related Terms
Frequently Asked Questions
Which is better: dollar-weighted or time-weighted return?
Neither is 'better' — they answer different questions. Time-weighted return measures the investment's performance (useful for comparing funds). Dollar-weighted return measures your personal outcome including timing of contributions. For evaluating your financial progress, dollar-weighted return is more relevant.
Why is my return different from the fund's return?
If you added money after a gain or withdrew after a loss, your dollar-weighted return will differ from the fund's time-weighted return. This is normal and happens to most investors. The gap highlights the impact of contribution timing on actual results.