We all invest for the same reason, yet we don't all get the same results. It isn't just the investments we buy. Timing your next contribution or Registered Retirement Income Fund (RRIF) payment is about to be part of the equation.
If you are lucky enough to receive a reported return on investments (ROI), you are likely being handed a time-weighted return calculation. This measurement determines how an investment has performed over the time that you've held it. Beginning this year however, under the Investment Industry Regulatory Organization of Canada (IIROC) new policy, all investment statements are required to produce an individual rate of return, also called a money-weighted return. This calculation is different because it's based on how much you have in the investment at the time that it increases or decreases in value. If you have more money at work during a period of poor performance, your return will be lower than someone who had withdrawn funds before the downturn. It's this aspect that makes the timing of your deposits and withdrawals affect the overall performance of your investment account rather than the long-term performance of the investment alone.
For example, consider an investment account that made five per cent every year except the sixth year when it dropped two per cent, to which you've been diligently making $1,000 contributions monthly. In the first year, you have much less in the account than you did in year six. In the time-weighted calculation, the return would be calculated higher than the individual (money-weighted) return because the greatest amount of your money was in the portfolio when the returns dropped, compared to the early years when the returns were consistent. Your portfolio was back-end weighted, so to speak. The opposite is also true. For investors who withdraw income regularly, You will have a drag on your overall portfolio returns if the performance picks up steam in later years since the money you've spent isn't able to participate in those higher yields.
There are practical uses for both return calculations. In the case of the time-weighted returns, it makes comparisons to an index much easier since indexes don't have money being added or withdrawn. It seems fair to compare returns where the amount of money being invested is consistent in both cases. For many investors however, money is added or taken out at various times, and your particular account produces a different return than a static investment does.
Using the individual return is better for you individually, since it's your actual return on your account. The drawback is that the responsibility is on you to better time your investment contributions and withdrawals, relative to what's going on in the market. It always was but now you will see the impact it has in black and white. Moreover, you may suddenly feel that your portfolio is outperforming or under-performing, yet the reasons may be linked to the timing of your investment contributions and withdrawals rather than the investment selection alone.
Ultimately, we all deposit money when we have it and withdrawal it when we need it but if you can keep this simple lesson in mind, you should increase the success of your investment strategy: Take money out when the market is up and put it in when the market is low. Yes, you've heard the buy low/sell high strategy before. Now it's in black and white with a percentage sign after it.
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