Calculating your return on investment (ROI) is simplified when you have only an initial value that grows over time. However, regularly depositing or withdrawing money complicates this calculation, because the influence of the additional cash flows is not considered with the standard formula, which calculates the starting and ending balance change. Simply adding these cash flows to the starting balance biases your calculation, because it doesn't factor in when the cash flows occurred. Using a time-weighted ROI calculation solves this dilemma by segregating the investment into periods separated by cash flow activities.
1. Look at your investment statement and look for any non-interest deposits or withdrawals. It should list a starting and ending balance for any such cash flow. As a simple example, suppose you started a investment account with $10,000. Three months later, it grew to $11,000, at which time you deposited an additional $2,000, bringing the balance up to $13,000. After three more months pass, the balance grows to $14,000, but you then withdraw $3,000 to reduce the balance to $11,000. After another six months, your balance grows to $12,000.
2. Segregate the total investment into periods between non-interest cash-flows. In the example, you would have three periods: Period one starts at $10,000 and ends at $11,000 before the deposit occurred. Period two starts at $13,000, because of the deposit, and ends at $14,000. Period three's withdrawal reduces the starting value to $11,000 and ends at $12,000.
3. Divide the ending values by the starting values for each period to calculate their growth factors. In the example, you would divide period one's $11,000 ending value by its $10,000 starting value to calculate a growth factor of 1.10. Likewise, period two's growth factor is 1.08, and period three's is 1.09.
4. Multiply each period's growth factor and then subtract one to calculate the overall ROI. In the example, 1.10 times 1.08 times 1.09 gives you 1.29. Subtracting 1 gives you an overall ROI of 0.29, or 29 percent.