Measuring the performance of a financial account that may have had deposits and withdrawals means answering five questions.
Your beginning balance: the balance at the beginning of the calculation period.
Your ending balance: the balance at the end of the calculation period.
Your mattress equivalent: the amount of money you would have had you kept your money under the mattress.
Your ANP (absolute net performance): the absolute amount of money that you made or lost with your investment. It is the difference between your ending balance and your mattress equivalent.
Your FREQ (fixed rate equivalent): the annual fixed interest rate that replicates the performance of your account. It is the fixed annual interest rate of a (somewhat idealized) savings account which, when seeded with the same beginning balance and subjected to the same deposits and withdrawals as your real account, has the same ending balance as your real account.
Benchmarking is the process of comparing your account's performance to what would have happened had you made all your deposits and withdrawals to an alternate investment, such as an index fund. To this end, GreaterThanZero first constructs a hypothetical account that contains the alternate investment as its only position and is subject to the same deposits and withdrawals as the actual account. Such a hypothetical account is called a benchmark account. The what-if question can then be answered by making the following comparisons:
Here, you'll look at the ending balance of the actual account, the ending balance of the hypothetical account, and the difference between the two.
Suppose the actual account has a FREQ of x% and the benchmark account has a FREQ of y%. This means that the investor was effectively running an x% savings account. Had she invested in the alternate investment, she would effectively have had a y% savings account.
The time-weighted rate of return measures the performance of a single initial investment in a portfolio, disregarding the effects of subsequent deposits or withdrawals. It is the appropriate performance measure for mutual funds, because a mutual fund's “deposits and withdrawals” are purchases and redemptions made by independent investors. It would not make sense to measure their collective performance.