Smart Money: Understanding rates

Share this article:
William C. Fisher
William C. Fisher
All CFOs are taught that past performance is not an indication of future performance. Performance data is only part of how investment consultants evaluate money managers — and they use it with caution. The impact of time-weighted returns versus dollar-weighted returns must be considered carefully.

Somet imes past returns from many years are used to get an expected return in any given future year. An example here is to use the stock, bond and inflation data bases from 1926 to 2011 (S&P / Ibbotson data). If we run a simulation for many future years using these databases, the average return (over the 85 years) will be less than the “expected return” (based on the probability of the events happening).

Bank Administration Institute established the time-weighted rate of return (1968) as the standard method for evaluating investment managers. Time-weighted returns are not affected by dollars moving into/out of an investment. Dollar-weighted returns are affected by flows of dollars into/out of investments, and this is what affects most investor returns.

How often do we read about great past performance for a money manager at which point dollars pour into such investments? Unfortunately, this happens much too often. If the investment then drops in value, the time-weighted return might be good but the average dollar invested might lose money.

Brad Stewart, CFO at Methodist Retirement Communities in The Woodlands, TX, says, “Most senior living organizations have dollars flowing into/out of investment accounts.”

CFOs need to know dollar-weighted investment results to know how they are doing. But, for consistency with reported money manager rates-of-return, it is recommended CFOs use time-weighted rates-of-return to make projections.

Remember, just combining numbers in any way will not do.
Share this article:

More in News

Nursing home antipsychotic use has dipped nearly 19% under national effort, latest figures show

Nursing home antipsychotic use has dipped nearly 19% ...

The percent of long-stay nursing home residents receiving antipsychotic medication has decreased 18.8% under a nationwide initiative that started in 2012.

Jimmo succeeds in getting Medicare coverage, two years after landmark case ended

Glenda Jimmo has reached a settlement with the federal government and will finally receive Medicare coverage for claims that were denied in 2007, which led her to file a class-action lawsuit over the so-called "improvement standard."

Breier named new CEO at Kindred

Breier named new CEO at Kindred

Kindred Healthcare announced Thursday that it has chosen a new top executive to lead its push toward creating a mammoth national brand. Benjamin A. Breier, the company's current president and ...