Calculate the right Returns on your Investments

Return on investment calculation is a useful exercise to determine whether the desired return from our savings can be generated or not. We come across many terms which confuse us regarding the real picture on our investment. So, today we would discuss some of these common returns calculated.

Absolute Return

The absolute increase in asset over period of time is known as Absolute return of investment. It is usually described in terms of percentage. It does not consider the time gap in between.

Suppose you, invest Rs 5000/- in 2005 and redeem in 2008 at Rs 20000/-, the absolute return is 300 times or 300%.

Simplified Annualized Return

It is similar to absolute return only that the required returns are given in terms of annualized return. It is a very rough estimate to calculate the return. Although, it is not wrong but can many times lead to very unrealistic analysis like similar growth in all invested years.

So, in the above example, if over 3 years the absolute return is 300% then, the simplified annualized return is 100% pa.

Compound Annual Growth Rate (CAGR)

CAGR gives annualised returns grown over time considering a rate, which would have been achieved if the investments have grown over steadily. In reality, the actual growth is not steady it fluctuates. It is best suited for long term investment especially for mutual funds which have fluctuating performances and an average on this compounding helps us to determine whether our investment is really going to meet the desired goal target.

Let us consider the same example, in three years the CAGR is 58%. This means that my investment grows at 58% pa.

Internal Rate Return (IRR)

IRR is the rate of return which determines whether the actual investment has generated sufficient returns in comparison to lowest cost of capital. It is helpful when we have multiple investments made at regular intervals or received interim payments. This return are more suited to study insurance returns considering that many times premium paying years are followed by repayment like in annuity or endowment. Also, the appreciation of a stock especially a high dividend yielding stock held for long time can be rated on this parameter rightfully.   

Real Rate of Return

Any return received on asset should be rightfully adjusted or corrected for the influence of price change or inflation on it. This will give you a correct picture on a realistic valuation. Suppose you assume, that the expected return on your investment is 10% pa and the general inflation is at 7% pa, then the real rate of return you earn on this asset is 2.80% pa. So, it is always wise to make a right choice.  

Some other things that influence on our returns

a) Inflation – As mentioned above, it is necessary to earmark the returns against the inflation to understand if we are earning better than existing inflation rate or not.

b) Benchmark – It is necessary to earmark the performance against a benchmark to adjudge the performance with the overall economy movement. It can be any Index earmarking. A standalone performance is not much of benefit to anyone to make a decision. It is necessary to compare it with the ideal benchmark.

c) Relative Return – It is a peer comparison to understand if the particular investment matches the performance of other variables/ companies working in the same environment.

So, we recommended that do not get blinded by huge growth in an investment because it is compared with time value of money, fluctuating returns and a lost opportunity to invest elsewhere to earn better.   

An example to summarize our concept on return on investments.

				Returns Comparison
Purchase Year	2010	Sell Year	2015	Absolute returns	Annualized returns	CAGR	IRR
Purchase Price	237	Selling Price	799	237%	47%	28%	26%
Qty	100	Qty	100
Value	23700	Value	79900
		Dividends earned during the years	25,050

 

Thanks and Regards

Team

Saarthi Financial Planner

Email: saarthifp@gmail.com

Facebook || Twitter || Blog || Google Plus || Blogger