Suppose I start the year with X dollars in my account. Over the course of two years I pull out profits 3-4 times, ending with Y the first year and Z the second year. How do I calculate my annual ROE for each year? TIA
To calculate your return you simply link the return between withdrawal dates. That is, you calculate your return each time there is a cash flow to or from your account, and then start the next period with the new balance. Then you just link the returns to arrive at the total return for the whole period. For example, say you start with 100K, on a certain date you have 120K in the account and you withdraw 40K. At a later date your account reaches 90K and you withdraw another 30K. So your total return over the whole period would be as follows: Period 1: you started with 100K and before withdrawal reached 120K, so your return for the period is 120/100-1=20%. Period 2: you had 120K, but took out 40K so your staring balance is 80K, and your ending balance before withdrawal is 90K so the return for this period is 90/80-1=12.5% Total return for the 2 periods combined is (1.2*1.125)-1=35%.
There are two methods: time weighted returns and money weighted returns. They both have their drawbacks and advantages and will give similar numbers but skew in different situations. You can look them up on Google.
You start with $100 and you arbitrarily start with 10 shares. Each equal to $10 ($100/10 = $10 per share) you make 50% so $150/10 =$15 per share You take out $30 You redeem 2 shares ($30/$15=2 shares) $120/8 = $15 you make 50% so $180/8 = $22.50 per share You take out $50 You redeem 2 shares ($50/$22.50 = 2.22 shares) $130/5.78 = $22.50 You made (22.50-10)/10 =125% this year
MTE - Thanks for the reply. Even I can do that math newwurldmn - Would the time weighted and money weighted calculations be in the vicinity of the quick way that MTE suggested? itsame - I follow but 125% would be the gain on the current shares. Methinks the gain for the year would be 105% (counting the cash on the side).
spindr0, The method I described is actually the time-weighted calculation. The money-weighted calculation is basically finding internal rate of return (IRR). The advantage of the time-weighted calculation is that it removes the size effect. That is, it's not affected by the account's size, while the money-weighted calculation is affected by the size.
I think the methodology will depend on your control over the money you are taking out? If you are taking the money out to live then you should probably use time weighted. If you are taking the money out to protect yourself then you should probably use money weighted.
Why would it matter what the reason was for removing money? It would seem to me that the return is the return (sounds like an Al Pacino line ) regardless of what the use for it was. No?
You're right if it's your money but if you want to properly reflect the returns of a strategy (as an investor allocating to a mgr would receive) it's best to use twrr....at least I think that's what the CFA says on such matters...if only there was someone who knew who was a CFA authority.