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Weekly Market Recap

Equity markets around the world rallied once again last week, driven by continued strength in earnings, notable progress on vaccine distribution, dovish commentary by Fed Chairman Jerome Powell, and some progress towards another round of economic stimulus in the US.

On the vaccine front, Sinovac Biotech announced that its vaccine was approved for use in China, Pfizer’s vaccine was approved for use in Japan, and the Biden administration announced that the US had reached deals with both Pfizer and Moderna for another 100 million vaccine doses from each company. Dr. Anthony Fauci now expects that any American who wants a vaccine will be able to get one in the spring (possibly as early as April).

Treasury markets responded to all of this good news by sending yields higher, with the 30-year breaching 2% for the first time since Feb 19th of last year (the same day equity markets reached their pre-pandemic peak). Meanwhile the 2s10s curve reached 110 basis points, the highest level since the pandemic began. Investment grade corporate credit spreads tightened by 2bp, not enough to offset the move in rates. Muni and high yield bond spreads tightened more vigorously, pushing prices higher in those markets.

Oil extended its 2021 rally, with WTI finishing the week up another 4.6%. As a result, the energy sector extended its lead as the best-performing sector so far in 2021, while utilities were the worst performer last week.

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Weekly Market Recap

Every Monday morning, download our Weekly Market Recap for Commentary and Data, with Economy and Earnings, Equity Valuation, Interest Rates, and Inflation, including infographic charts.

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FAQ: Bitcoin 101

Bitcoin, and more broadly cryptocurrencies, are seeing increasing news coverage. This has left many wondering: “What is bitcoin and how does it work?” For those trying to better understand bitcoin and cryptocurrencies, here’s our understanding on a handful of frequently asked questions:

What is bitcoin?

Bitcoin is a digital “currency” that can be used to purchase goods and services (only at select locations, for now), or held as a store of speculative value. There are many differences between bitcoin and traditional currency, but the principal difference is that bitcoin is not issued by a government or regulated by a government entity.

Where did bitcoin come from?

This is where it gets a bit mysterious. Bitcoin was created by “Satoshi Nakamoto”, an unknown individual or group of individuals. Under this pseudonym a white paper was circulated in 2008 that first described the concept for a transparent, visible peer-to-peer payment system authenticated by a vast network that does not require the presence of a third party middleman – such as banks or other financial institutions. By combining cryptography and unique software protocols, Satoshi Nakamoto originated a payment system that allowed participants to transact directly with one another.

How is it possible to make currency transactions without banks?

Bitcoin transactions have been made possible with the encryption technology underpinning cryptocurrencies known as “blockchain.” Blockchain is a global Internet-wide distributed network that is at its core a decentralized accounting ledger recording every bitcoin transaction. The blockchain ledger is shared by way of an extensive network and the information therein is validated by network “miners” every ten minutes by solving mathematical puzzles using very fast computers and high amounts of electricity. This network validated ledger is crucial as it ascribes proof of ownership to digital assets like bitcoin. If the ledger proves ownership, participants can have trust when making transactions.

Tying together the concept of bitcoin and blockchain, think of it this way – the bitcoin “coins” themselves are simply seats within the aforementioned blockchain ledger. Anyone can buy into or sell out of this ledger at any time – with no prior consent, and with little-to-no fees. Therefore, when buying a bitcoin you are essentially acquiring one of a number of fixed slots within this ledger. You leave the ledger by selling your bitcoin to someone else who wishes to buy in.

If I want to buy bitcoin, how would I make a purchase? Do I need to buy a whole coin?

There are many exchanges out there that allow participants to deposit US dollars (or other widely accepted global currencies) directly from traditional bank accounts in exchange for bitcoin. Some cryptocurrency exchanges also have mobile apps allowing participants to buy bitcoin anytime, anywhere.

Additionally, participants need not buy a whole bitcoin to participate. The smallest unit of bitcoin, a “satoshi”, is the size of one hundred millionth of a single bitcoin (0.00000001 BTC).

What are the risks to purchasing and holding bitcoin? The current price seems high!

It depends on the type of risk one is referring to. Let’s start with general cybersecurity threats. Cryptocurrency exchanges, including those which trade bitcoin, have been hacked before, and will likely be hacked again. Perhaps the most notable example was in 2014 when “Mt. Gox”, the largest bitcoin exchange at the time, failed as a direct result of hackers and vast bitcoin theft. Security surrounding cryptocurrency exchanges have notably improved since Mt. Gox’s failure. Individuals can use bitcoin digital wallets and vaults that are encrypted with a secure network key which dramatically reduces the possibility of being hacked.

Another key risk worth touching on is the possibility of loss of capital for those speculating on its price. Bitcoin has experienced a monumental run as of late. There are a variety of opinions and market variables as to why this has occurred. Will this price rally continue, or crash? Nobody knows for sure. However one way to think about it is, by design, bitcoin was given a finite supply – determined at inception to be 21,000,000 bitcoins – and we are now seeing growing awareness leading to rising demand. This basic supply / demand dynamic may help describe, at least at some level, recent price moves in bitcoin. That being said, just because more cryptocurrency enthusiasts are now entering the market seemingly pushing up prices does not mean everyone should take a position. With a greater understanding of bitcoin – both its potential opportunities and risks – paired with careful holistic wealth advice, more educated decision making can be made on potential bitcoin / cryptocurrency participation.

We hope that this FAQ provides a helpful introduction to bitcoin / cryptocurrencies, and perhaps even sparks your desire to want to learn more. The investment team at Albion Financial Group is well versed in bitcoin / cryptocurrencies and blockchain technology. Please reach out to us at 801-487-3700 or info@albionfinancial.com if we can answer your bitcoin, investment, or financial planning questions.

Disclaimer: Information provided is for educational purposes only. This is not a recommendation to buy or sell any security or cryptocurrency. There are significant risks associated with cryptocurrency that are unique and must not be taken lightly. It is critical that you perform your own due diligence prior to engaging in any buy or sell transaction. The value of bitcoin, or any cryptocurrency can, and may, ultimately go to zero.

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Conference Call Recording – November 5, 2020

Listen back to Albion’s November conference call.

  • 00:00  John Bird, President & CEO – Introduction
  • 03:27 Jason Ware, CIO – Markets & Economy
  • 11:54 Doug Wells, Partner – Planning Strategies
  • 26:09 Q & A
  • 27:28 How is potential regulation of “Big Tech” affecting our investments?
  • 33:23 What should I be doing to protect my portfolio in the context of so much ambiguity?
  • 41:21 Who can I talk to if I am anxious about my portfolio for any reason?
  • 43:18 With the ongoing pandemic and a potential change of president, are there investment changes I should make?
  • 48:48 Conclusion
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Conference Call Recording – October 6, 2020

Listen back to Albion’s October conference call.
00:00 – John Bird, President & CEO: Introduction
14:01 – Jason Ware, CIO: Markets and Economy
28:17 – Liz Bernhard, Senior Wealth Advisor: Planning and Tactics
41:44 – Q&A

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From the desk of Doug Wells: “Should You Invest More Money in the Stock Market?”

It is now four weeks since the March market lows. We have more information on how the pandemic will impact our lives and the economy and we have seen both bad and good come out during this unprecedented time.

Sadly, we have seen the virus spread quickly to every state in our nation.  Nationwide there have been over 750,000 cases and over 40,000 deaths. Many of our favorite local businesses have temporarily closed or dramatically scaled back their services, all of us know at least a few people who have lost their jobs and most of us have been sheltering in place for over four weeks.

There has also been uplifting news. Many of our neighbors have become local heroes by opening their hearts to help others – whether that be through grocery runs for others, celebrating a child’s birthday with a drive-by parade or health care workers continuing to risk their own well-being every day to help those infected. In addition, we have seen positive news on vaccines (J&J, Moderna, and others) and potential drug therapeutics (Gilead).

While the current situation remains scary, many of us have settled into our new temporary reality. And, the stock market has done the same. Since the March 23 lows, the market has made up roughly half of its losses and rebounded approximately 30%. As we adjust and get a bit more comfortable with our new daily routine, some people are asking “If I have additional capital, should I invest more in stocks?” As with most questions, the answer is – it depends. Below are a few of the factors to consider if you are contemplating investing new money into the stock market:

What is the purpose of each of my accounts? 

Most people have several accounts, each with different goals, and you want to make sure your investments match your goals. For example, you may have several college savings accounts for your children or grandchildren, an emergency fund with 6 months to 2 years of living expenses and your retirement accounts. The right answer for one account likely will not be the right answer for all of your accounts. For instance, your emergency account should be held in cash or high-quality liquid investments (like US treasuries). Adding equity exposure to this type of account likely does not make sense. For college savings accounts, it depends on how soon the beneficiary will need the money and your ability to add additional funds should the need arise. If the college funding is needed in the next 1-3 years, adding equity exposure likely does not make sense. However, if the child does not need the funds for 7-10 years, adding some equity exposure might make sense. For retirement accounts, if you have 5-7+ years of living expenses in bonds and/or cash, it might make sense to consider investing any new money in stocks.

Timeline – Strategy: What is the investment timeline for this new money?

Each market correction is different. In some cases, new highs are reached after just a few months. In other cases, it can take a few years. And, occasionally, it can take longer. Only invest new money in the stock market that you don’t need for several years, preferably 5 years or more.

Timeline – Tactical: How quickly should I make new investments?

Trying to call “the bottom” is an expensive exercise in futility. Yes, you might get lucky but, more likely, you will miss your opportunity. Most investors are far better off splitting their money into 4-6 tranches and investing regularly over a period of time. For example, invest 1/6 th  of the new money on the first trading day of each month for the next 6 months. This allows you to dollar cost average into new investments. A quick side note. If you believe the market will be higher in several years than it is today, you actually want the market to continue to fall as you invest as it will give you a lower average cost basis for your new investment.

What is my personality?

For investing, it helps if you are an optimist who believes in a better tomorrow. Yes, the next few months, and possibly years, will be challenging. Some companies will miss their earnings estimates, unemployment will almost certainly continue to rise to previously unthinkable levels, new coronavirus infections and deaths will continue, some cities and states will have setbacks after reopening their economies and there will be other expected and unexpected challenges. However, there will also be unforeseen positive developments such as promising news about vaccines and drug therapies, success stories from hospitals, cities, and states, additional fiscal policy support from the state and federal government and more. The point is, can you weather the bad news and a declining stock market if it continues over many months? Remember, your timeline for any new money invested in the stock market should be 5 or more years. That can be a  very  long time in a negative or flat market.

What is my goal?

I would argue that your goal should be to make a series of good financial decisions over several years. You will not get every decision “right”. But, if the vast majority of your decisions are sound and your mistakes are modest, you will likely do very well over time.

Is now the right time to start?

As I write this note (Sunday evening 4/19/2020), the S&P500 is at 2,875 – down just 11% year-to-date and very close to levels last seen in October of 2019. Think about that. If six months ago you had perfect clairvoyance and knew a global pandemic was coming and it would halt the world’s economies (and many of the small businesses in your neighborhood) what would you have predicted the stock market would do? “Flat” would not have been my prediction. Yet here we are.

At these levels, it feels as though there is a fair amount of optimism regarding the re-opening of the economies around the world, the power of unprecedented fiscal and monetary policies from various governments and the progress on drug therapies and vaccine candidates. Yes, I am optimistic on what the world looks like in 2 years. However, I am also a realist on what the path to get through this likely entails. The reality is that we will have some tough weeks and months in front of us as well as some heartbreaking setbacks in our fight against this virus.  It is impossible to know when the market bottom will happen.

Given the fear and uncertainty, a course of action could be to wait and start your first tranche of investing should the market fall another 5-10% from these levels.  But be clear this carries two big risks; first, the market may not correct the amount you’ve defined as your entry point causing you to leave you funds on the sideline. Second, you can be certain the headlines will look dreadful if/when the downdraft occurs. Will you be willing to buy in the face of really bad news?

In summary, is now a good time to invest new money? Maybe. But it is definitely a good time to plan how you intend to add to your equity exposure regardless of what the market does over the next several months.

On a similar note, if you found your portfolios a bit too aggressive in your current asset allocation, it makes sense to reevaluate and possibly de-risk some of your investment accounts. Your aim is for your asset allocation to match the specific account’s goals. With the market down just 11% year-to-date and at levels close to those seen in as recently as October of 2019, it may be a good time to evaluate a change like this.

Our goal is to help you make good financial decisions; often this includes helping you avoid short-term thinking with long-term assets (or, conversely, long-term thinking with short-term assets). Please reach out to your Senior Wealth Adviser if you would like to discuss any of the ideas shared in this note and how they might relate to your specific situation. Also, if any of your colleagues, friends or family are struggling to make good financial decisions during this stressful time, please feel free to let them know about Albion. We would be honored to have a conversation with them to see if Albion can be of service.

Doug Wells
Partner
Albion Financial Group

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2019 Planning Guide: What You Need to Know

At Albion Financial Group, we believe in the importance of quality advising where financial success is a result of a series of good decisions over time. Multi-year financial advice on investments, tax planning, retirement savings, college education, Social Security and estate planning strategies can help protect income and grow wealth.

The start of a New Year is a good time to review your financial strategies to ensure they are aligned with your goals – an expertise we bring to bear for our many client families. We aspire to be a financial resource to you and in that spirit this blog post contains our 2019 Planning Guide to assist you in making informed choices. This guide is designed to be a quick reference for tax rates, savings and retirement contributions, college savings strategies, as well as Social Security and Medicare information. We hope this infographic is a helpful resource as you navigate many of life’s financial decisions.

Everyone’s financial situation is unique – the information found in the 2019 Planning Guide should only be used as a foundation for discussing your individual circumstances with a CERTIFIED FINANCIAL PLANNER™ practitioner, legal or tax professional.

The wealth advising team at Albion Financial Group understands the complexities of the current wealth management environment and would be honored to discuss your financial situation and strategies that may help you reach your personal financial goals. Please give us a call at (801) 487-3700 or email dpope@albionfinancial.com.

We wish you a prosperous 2019.

Devin Pope, CFP®, MBA
Senior Wealth Advisor
Albion Financial Group

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Financial Literacy Building Blocks for Kids

Financial decisions were once much simpler. Let’s rewind the clock to a time when, after graduating from high school or college, individuals would begin a job at a company where they would remain for the entirety of their career. Cash inflows were simply a pay check while working, followed by a pension in the golden retirement years. Employers would fully cover the cost of health insurance, and, upon retirement, Medicare would substitute. Banking would occur at a local bank where tellers were identified by their first name, and interest was paid on cash savings. If there was excess cash in a checking account, conservative investing would take advantage of the power of compounding.

Let’s now fast forward to today where it is the responsibility of each individual to decide how much to save for retirement, where to save, how to invest, when to pay off various debts, as well as what to do about health insurance and healthcare costs. In a time where endless information can be found on the internet at the click of a button and where the choices available to consumers are infinite, individuals must have a solid financial literacy base in order to make good financial decisions.

Now, more than ever, it is essential to teach financial literacy skills to our children. Here are some financial literacy building blocks:

As a family, craft a clear set of values regarding spending, investing, and philanthropy in your home. What does it cost to run a household? What percentage of monthly pay checks are saved each month? Are donations made to charities in volunteer hours or dollar gifts? Which particular charities are supported?

Make time for family discussions about money. It’s very important to talk with children about why you do things the way that you do them in your household. As parents, practice what you preach. If you teach your children about the importance of saving, and then children see you spending all of the money entering your household, you are sending a mixed message. Children will pay attention to the action rather than the verbal message.

Young children can begin to learn about money and adopt early skills needed for a lifetime of currency use. Teach young children about different currencies. Practice counting and exchanging coins and bills with them: four quarters for a dollar bill, a five dollar bill for five one dollar bills. Simple games such as “store” or setting up a lemonade stand are fun ways for children to gain comfort with money. Help kids understand prices, purchases, and how to make change. Have your child open their own library card and explain the library trusts the child to return borrowed books or they will owe a fine. This is a way for kids to begin their first credit relationship.

Giving children a chance to practice money skills while the stakes are relatively low is critical. Using an allowance as a financial teaching tool is a great place to start a financial education. A good rule of thumb for allowance is a dollar a week for each year of age. For example, an eight-year-old would receive eight dollars paid in cash on the same day each week, and then going up to nine dollars after her next birthday, and so on.

It’s a good idea to separate allowance from household duties like making the bed, keeping the bedroom clean, and emptying the dishwasher—in other words, expected household contributions that do not warrant compensation. Create opportunities for children to earn money by doing jobs around the house that are above and beyond expected household duties. Make a chart that shows the monetary value of each of those other household jobs: mowing the lawn earns five dollars or organizing the pantry earns four. When you pair allowance with work, you show children the relationship between performing a job and earning a wage.

Be consistent and clear with when allowance will be paid and how their money can be used according to parameters decided upon as a family. Families may determine that allowance should be split into thirds: a third saved, a third given to charity, and a third to spend. Give children the freedom to spend the money that is set aside for spending. Encourage comparison shopping and thinking twice before making purchases. It is also helpful to talk about needs versus wants. Clothing is a need, while the fancy new t-shirt designed by a skateboard professional is a want.

As your children mature, begin to pay allowance in advance. By paying allowance monthly or quarterly, you allow older children to practice long term budgeting. Work with kids to create an itemized budget and track expenses. Overtime, talk about what is working in their budget as well as where they have over-spent or under-estimated. The goal is to help children shift from relying on their parents to relying on themselves.

With age, financial literacy activities can become more complex. Have your ten-year-old track a utility bill for six months. A good example is the cell phone bill. Look at how many minutes each person uses and how much data is used in a given month. How does the expense change month-over-month? What can be done to decrease the bill when the expense is high? How much of your household monthly budget is this cell phone bill?

Encourage children to think about what they would like to be when they grow up and facilitate research on the average salary for the desired profession. Let’s say they chose a circus performer. How much does one earn each year? If the circus performer had to save one third of earnings, how much is left to spend on new circus props? Have them look at different career paths and study the level of education or training needed for a particular career. Then, look for schools that specialize in this training and find the cost associated with the training. Children also love stories of entrepreneurs. Share entrepreneurial stories about professionals working in areas that your children are passionate about.

It is never too late to begin discussions about financial literacy. To be successful, we need to educate both ourselves and our children. Financial literacy skills are critical and they can also be a lot of fun.

Sarah Bird, CFP® / Senior Wealth Advisor
Albion Financial Group
sbird@albionfinancial.com
(801) 487-3700

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Debt or Equity: Which is the Best Way to Raise Capital for Your Business?

My first job out of college was with a Fortune 100 company that measured success by market share and revenue. When my team saw opportunities to strengthen our market position, we simply put together a budget and submitted it for funding. Senior management either approved the project or turned it down. Money was a figure on a spreadsheet and we had a seemingly endless supply.

I look back at this experience nostalgically as one might reflect on their childhood. Fun days, but boy was I naive. If you don’t have the balance sheet of a Fortune 100 company, how do you raise money to support growth, develop new products or pursue opportunities? Company owners generally have just three sources for capital: retained earnings, debt or equity.

Retained Earnings (your company’s profits)

The cheapest source of capital is always your company’s retained earnings. Run your company profitably and each month the balance of your business bank account grows. Sometimes, however, the best long-term decision is to invest more money than your company can earn and save. For this, you will need debt or equity.

Debt (a loan from friends, family or the bank)

Debt is generally less expensive than equity but can be difficult to obtain and often comes with constraints on the business.

Owners who think they may want to pursue debt in the future are well advised to work with a knowledgeable accountant to make sure all their financial books are in order. Build relationships with banks well before you need money and periodically keep them apprised of your company’s progress. Nothing builds confidence with a banker like seeing a business meet its goals quarter after quarter and year after year—particularly when that business is not yet asking for a loan.

Perhaps the most daunting part of incurring business debt from a bank is the personal guarantee. If the business fails, the company owner could lose some or all of their personal assets. Banks always say that the personal guarantee is non-negotiable; however, the rigidity of this requirement changes over time. In other words, sometimes it is more non-negotiable than others. If a personal guarantee is a deal breaker for you, consider hiring a professional debt broker. Unfortunately, finding a good debt broker can be more difficult than finding a bank to lend you money.

Equity (selling a partial ownership stake in your company)

Equity is typically more expensive than debt, but it comes with greater flexibility. One of the most compelling features of equity is the access to advice and support that comes from a good investor. Unfortunately, the opposite is also true—a bad investor can make your life miserable. Like a marriage, you are entering into a relationship and it is worth spending time to find the right partner. Networking with other entrepreneurs and business owners is one of the best ways to find good investors.

Other resources are investor groups such as the Park City Angels or the Salt Lake City Angels. Venture investors with a focus on Utah companies include Kickstart Seed Fund (early stage) and Mercato Partners (growth capital for expansion stage companies) as well as several others.

If at all possible, you want to be introduced to the investors you would like to approach. While often overlooked, one effective way to get an introduction is simply to see what other companies the firm has invested in and meet with the founders of those companies (investment firms typically list their past and existing investments on their website). Entrepreneurs love meeting with other entrepreneurs and will often agree to help with an introduction. With LinkedIn and other tools, finding someone you know in common with the desired investor is easier than ever.

Take the time to arrange a quality introduction, as it is your first impression and is sometimes a test. The test relates to this question: If you can’t get a quality introduction, how will you get in front of customers, suppliers, etc.? That said, if you aren’t properly introduced, don’t hesitate to pick up the phone and introduce yourself.

Run your business well and maybe one day you will build the next Fortune 100 company. If you do, one last piece of advice: Don’t hire recent college graduates who naively think the essence of raising money is submitting pretty spreadsheets (like I did 25 years ago …).

Doug Wells, CFA, CFP, MBA
Principal
Albion Financial Group
(801) 487-3700; (877) 487-6200
dwells@albionfinancial.com

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White Paper: Dollar-Weighted Versus Time-Weighted Returns – Should You Care?

Imagine; you invest $100,000 in a stock. Six months later you put another $100,000 into the same stock. Six months after that you sell all your shares for $300,000. After a few rounds of self- congratulation on your stock picking prowess you decide to calculate your return. You know you invested $200,000 and had gains of $100,000. Since your gain of $100,000 is 50% of the $200,000 invested your gain is 50%. While this is a straightforward calculation something doesn’t feel quite right. Should the fact that only half the money was invested initially with the other half invested midway through the time period cause you to adjust your calculation? In search of answers you go online and find two rate of return calculators. You enter your data and click to the answer. One says you earned 66%, even better than your own calculation had indicated. But the other says your rate of return was… Zero. Yes, zero. Something must be wrong. You recheck your data and determine that both answers are correct. Welcome to the exciting world of dollar-weighted versus time-weighted returns!

Ever since assets have appreciated people have worked hard to come up with methods to quantify their profit. At its simplest, the appreciation calculation is straightforward. Just divide the amount the investment appreciated by the initial value of the investment as in the example above where the $100,000 gain was divided by the $200,000 investment showing a rate of return of 50%.

However it starts getting a bit more complicated if during the period the performance is being measured money is added to or taken from the investment account. Dollar-weighted and time weighted return calculations are the two methods that account for cash inflows and outflows during the performance measurement period.

Let’s look at dollar-weighted returns first. While the calculation is straightforward the details are challenging. All you have to do is divide the gain by the average capital base. Gain is the amount left over after subtracting all the money put into the investment. Average capital base is a bit trickier; it is the sum of the initial investment plus or minus any funds added to or removed from the investment after the start date, adjusted for the time period the funds were in the account.

That’s a tough sentence; here is an example:

Suppose we start our investment account with $100. Six months later we add another $100. Six months after that we want to measure the performance for the previous 12 months. What is the average capital base? It is the initial $100 plus half of the second $100 added to the account, for a total of $150. Only half of the second $100 is included because it was only invested for half the period. If instead of adding funds, $50 had been removed from the account halfway through the performance period, the average capital base would have been $75; the initial $100 minus half of the $50 that was removed.

The advantage to the dollar weighted calculation compared to the basic calculation where gain is divided by the amount invested with no adjustment for cash inflows and outflows is that the dollar weighted calculation modifies the performance to reflect the gain relative to the funds actually available for investment.

Time weighted return takes dollar weighted returns one step further. In calculating time weighted returns, first you divide the performance period into smaller time periods; quarters, months, weeks and days are typical. Then for each of these smaller time periods a dollar weighted return is calculated. Finally, these smaller period returns are compounded to generate the time weighted return for the whole performance period.

Using time weighted returns further diminishes the impact of cash inflows and outflows on the actual return of the assets in the portfolio. A bit of math clarification is in order. When compounding multiple periods of return you must add 1 to each percentage number and then subtract 1 from your final result. Here is why. Suppose you are compounding quarterly and for three quarters in a row you earn 5% per quarter. Mathematically 5% is 0.05 so if we multiply 0.05 * 0.05 * 0.05 we get .0001, or one tenth of one percent. Whenever you multiply any number by a number less than 1 the product will be less than the initial number.

So here is what to do; add 1 to each percentage to be multiplied then subtract 1 from your answer:

1.05 * 1.05 * 1.05 = 1.16
1.16 – 1 = .16 = 16%.
5% per quarter compounds to a 16% total return after three quarters.

So which return calculation makes the most sense? It depends. The basic “gain divided by amount invested” calculation which does not take into account cash inflows and outflows provides the most clarity when you are trying to figure out how many more (or less) dollars you have than you did before investing. But it does not capture the impact of cash moving in and out of the investment account.

Dollar weighted returns capture more than just the return of the assets in the portfolio. They also give you a better idea of the returns earned on the money you had at risk. If your advisor helps you determine when to add funds to the account, or when it makes sense to pull money out, the dollar weighted return is more likely to highlight the impact of that advice. More typically, cash flows into or out of an account are driven by the client and are based on cash flow needs, savings strategy and other life events.

If you want to hone in exclusively on the impact of the investment decisions made within the portfolio then time weighted returns are likely the better measure. However most investors will find that investment portfolios experiencing large inflows and outflows will have time weighted performance that differs from managed portfolios that do not have such contributions and withdraws.

Of course if there are no cash inflows and outflows after the initial investment then all three performance calculation methods; gain divided by amount invested, dollar weighted, and time weighted, will show the same investment return. (great point …. Correct but not intuitively obvious).

Back to that opening problem; why did one performance method show a 66% return while the other showed a 0% return? Here are more details on the twelve months of investing. During the 12 month period the $100,000 investment lost half its value, to $50,000, in the first six months at which point an additional $100,000 was added. In the second six months the investment doubled in value so the $150,000 grew to $300,000.

First we’ll calculate the dollar weighted return which is the gain divided by the average capital base. The gain is $300,000 less the $200,000 that was invested, or $100,000. Next comes the average capital base. We had $100,000 for the full period and $100,000 for half the period for an average capital base of $150,000. $100,000 gain divided by the $150,000 average capital base is .666, or a 66.6% return. Not bad.

Next we’ll calculate the time weighted return and we’ll do it by calculating the dollar weighted return for two time periods and then compounding them. For the first six months the stock declined by $50,000 and the average capital base was $100,000 for a return of -50%. For the second six months the stock appreciated by $150,000 on an average capital base of $150,000 for a return of 100%. To compound these two periods we add 1 to each return and multiply them together:

First, add 1 to each period return;
1 – 50% = .5
1 + 100% = 2

Then multiply the adjusted return numbers together;
2 * 0.5 = 1

Finally, subtract the 1 from your result;
1 – 1 = 0 which equals 0.0%

Performance measurement should be a detailed and accurate exercise following prescribed performance calculation standards. Yet even when the calculations adhere to a standard the results can vary significantly depending on which performance calculation method is used. Next time you’re quoted an investment return you’ll know to ask a few follow-up questions to ascertain what the investment in question might have actually done for you.

John Bird, MBA, CFA, CFP / President
Albion Financial Group
jbird@albionfinancial.com
(801) 487-3700