There are various ways you can calculate investment return. Know about the broad types of returns to know how you can evaluate performance of your investment.

Return on investment is a basic computation made to assess how an investment is performing. Return can be measured in three ways:

1.) Absolute Returns

Comparing the amount of inflows and outflows on an investment in absolute terms. In mathematical terms an absolute return can be calculated as:

Absolute return = (Ending value – Beginning value) ÷ Beginning value X 100

2.) Annualized Return

Computing an annualized rate of return by comparing inflows and outflows.

Annualized return = (Ending value – Beginning value) ÷ Beginning value X 100 X (1/Holding   period of the investment)

Annualized return can also be calculated in the form of Compounded Annual Growth Rate (CAGR). We will develop detailed understanding of CAGR in tomorrow’s lesson.

3.) Total Return

Total Return is the return computed by comparing all forms of return earned on the investment. For example, dividend payment, interest payment, bonus payment. Thus total return is the annualized return after including all benefits on the investment.

Total return = (Ending value – Beginning value + additional benefits) ÷ Beginning value X 100 X (1/Holding   period of the investment)

Comparing the above 3 types of returns and why they make a difference.

Let’s say you invested Rs 1 lac and it became Rs 1,16,664 lacs (8% p.a.) in 2 years. We will use this example to calculate returns as per the above mentioned methods.

I.         Absolute return = (Ending value – Beginning value) ÷ Beginning value X 100

=          (116664 – 100000) ÷ 100000 X 100

=          16.6 %

II.         Annualized return = (Ending value – Beginning value) ÷ Beginning value X 100 X (1/Holding   period of the investment)

=          (116664 – 100000) ÷ 100000 X 100 X (1/2)

=           8.3% p.a.

III.         Total return = (Ending value – Beginning value + additional benefits) ÷ Beginning value X 100 X (1/Holding   period of the investment)

Let’s say a dividend was also paid in second year, Rs 5000.

=           (116664 – 100000 + 5000) ÷ 100000 X 100 X (1/2)

=           10.8% p.a.

The rate of return that you should ideally be looking at during investment’s is the Annualised rate of return and your aim at the minimum should be to beat inflation. E.g. in the scenario above, if the inflation was 7% in the last 2 years, then your net increase in value of money was actually 1.3%. However, if you consider it with Absolute or total returns, then the figures can appear higher than they really are.

This is also a tactic most insurance agents use to ‘fool people’ – Their pitch will usually go like – “Invest Rs 500,000 this year and at the end of 15 years, you will get Rs 13 lakhs – a return of 157% ” Most people will think in absolute terms while the real annualised returns are much lower and often lower than even inflation thereby destroying your money in the process.