Starting in July 2016, dealers and advisors will be required to provide a personal rate of return to their clients.  Although this disclosure is a step in the right direction, it will likely lead to more confusion and frustration amongst clients and advisors if the results are not properly explained.  There are various ways to calculate a rate of return – and each of them can add to your understanding of how your portfolio is doing.  In my next series of blog posts, I will explain some of the most popular rate of return methodologies, and also provide some easy to use calculators for those investors who prefer to get their hands a little dirty.

To illustrate the impact that a chosen return methodology can have on a portfolio’s reported performance, we will compare two investors who invest \$250,000 on December 31, 2013 into an index fund that tracks the MSCI Canada IMI Index.  We will assume that neither investor pays any product fees, and that the security tracks the index perfectly (Note:  I have used actual index values in my examples in order to make the results more relevant).

After a period of relatively good performance, Investor 1 decides to contribute an additional \$25,000 to their portfolio on September 15, 2014.  Investor 2 decides that they would like to take some profits off the table, and instead withdraws \$25,000 from their portfolio on September 15, 2014.

In the charts below, the month-end market values for 2014 are included for both investors.  The dates and amounts of any contributions (positive external cash flows) and withdrawals (negative external cash flows), have also been included (as well as the new market values after the cash flow occurs).

Throughout the examples, you will need to continually refer back to these charts, so keep them handy as you work through each calculation.

For the next blog post, we will examine the time-weighted rate of return (TWRR).

Chart 1:  Investor 1 – \$25,000 Contribution

 Date Market Value (MV) Cash Flow (CF) MV After Cash Flow December 31, 2013 250,000 January 31, 2014 251,938 February 28, 2014 262,212 March 31, 2014 265,256 April 30, 2014 271,900 May 31, 2014 270,962 June 30, 2014 282,868 July 31, 2014 287,098 August 31, 2014 293,108 September 15, 2014 290,621 + 25,000 315,621 September 30, 2014 304,818 October 31, 2014 297,125 November 30, 2014 299,406 December 31, 2014 298,082

Chart 2:  Investor 2 – \$25,000 Withdrawal

 Date Market Value (MV) Cash Flow (CF) MV After Cash Flow December 31, 2013 250,000 January 31, 2014 251,938 February 28, 2014 262,212 March 31, 2014 265,256 April 30, 2014 271,900 May 31, 2014 270,962 June 30, 2014 282,868 July 31, 2014 287,098 August 31, 2014 293,108 September 15, 2014 290,621 – 25,000 265,621 September 30, 2014 256,530 October 31, 2014 250,055 November 30, 2014 251,975 December 31, 2014 250,860