Understanding IRR vs. TWRR Through an Analogy
When comparing investment performance, two of the most common measures are Internal Rate of Return (IRR) and Time-Weighted Return (TWR). While they sound similar, the difference lies in what question you’re trying to answer.
IRR reflects the return with cash flows included, that is, it accounts for the timing of money going in and out. For private equity or infrastructure funds, where contributions and distributions happen over time, IRR helps measure how well an investment manager turned those cash flows into profits.
TWR removes the effect of cash flows. It measures performance in a way that can be fairly compared across investment managers, since it shows how a dollar invested at the start of the period would have grown regardless of when contributions or withdrawals occurred. This is why TWR is often used for public equity markets or performance reports.
Okay, let’s use an analogy.
The Road Trip vs. the Commute
Imagine you’re trying to measure how well you get from Point A to Point B.
IRR is like your road trip. You care about the entire journey, including how much gas you put in, when you stopped for snacks, or whether you got stuck in traffic. The timing of those stops (cash inflows and outflows) directly affects your overall experience. If you left early and hit no traffic, your trip looks great. If you stopped late and hit rush hour, your trip looks worse. In other words, IRR is sensitive to when money is added or withdrawn from an investment.
TWRR is like your daily commute. You don’t care about gas stops or detours; you only measure the average speed of the route itself. By looking at the route in segments—say, every mile—you can figure out the overall pace regardless of when you left or how much gas you used. TWRR strips out the effects of timing cash flows and focuses purely on how the investment itself performed.
For pension funds managing billions of dollars, the distinction is crucial. IRR highlights the investor’s actual experience, factoring in the timing of contributions and withdrawals. TWRR measures the manager’s performance by showing how the investment strategy performed independent of cash flows.
If your pension plan invests heavily in private equity, you’ll likely see IRR in the reporting. But IRR can sometimes make performance look better (or worse) depending on the timing of cash flows. TWR offers a clearer, apples-to-apples comparison across all investment managers, but it might not capture the “real” experience of limited partners whose contributions arrive at different times.
That’s why strong governance often calls for reviewing both metrics together. Doing so helps trustees see not only how managers are performing against benchmarks but also how members’ money is actually working over time. And when thinking about climate finance, this distinction matters even more: some climate-aligned investments may take longer to pay off but could reduce risk and deliver stronger returns for members in the long run.
Together, they offer a full picture: IRR shows what the investor earned, while TWRR shows how well the investment was managed. Both are important tools for accountability and for making decisions about where pension assets should be directed in the future.
Note: This analogy was generated with the support of AI.
