During an investment period, the account records the inflows and outflows of capital. The size and timing of capital flows affect the return on investment. These inflows and outflows can distort the return on the account, either by overvaluing or undervaluing the return because of the effects of inflows or outflows.
As an example, let's take an account with a return of 7% at the end of an investment period. If 3% is attributable to a booking of funds on the last day of the investment period, the return shown will not be a complete picture. The 3% return due to the inflow of capital distorts the return on the account.
To give a clearer picture of the return, an investment period is shown in sub-periods. Each sub-period reflects a capital entry or exit event, with the effects of capital flows being included in the return calculation, within the sub-period in which the capital flow is relevant. Saxo splits the sub-periods into trading days so that the capital flows are the sum of the capital flows on a given trading day.
For the calculation of the time-weighted return, the time (sub-period in which the capital flow took place) and the size (amount of the capital flow) are taken into account.
The example below illustrates an investment period with two sub-periods. The investment has a value of EUR 1000 at the beginning of the day on May 2 and rises to EUR 1250 at the end of the day on May 2. On May 3, a bank transfer of EUR 200 is received on the account, bringing the account value to EUR 1450. The investment is worth EUR 1650 at the end of the day, on May 3rd. The investment period is divided into two sub-periods: May 2, where the account value increases to EUR 1250, and a second sub-period, May 3, where there is an inflow (transfer) of EUR 200 in growth in account value. The time-weighted return is then calculated by first calculating the return for each sub-period:
The time-weighted return is then the cumulative return of all sub-periods, with the sub-periods multiplied together and expressed as a percentage: