Calculate your portfolio's rate of return

Rate of return is a fundamental concept for all investors, whether novice or experienced. Regularly calculating your portfolio's rate of return is essential for assessing the effectiveness of your investment strategies, identifying opportunities for improvement and making informed decisions to maximize your gains. Would you like to master the fundamentals of finance? Join our Master of Science Finance to work in targeted areas of expertise such as credit management, reporting and risk management.

What is a rate of return?

The rate of return is an essential measure that enables investors to understand how much money their portfolio is generating over a given period. It is expressed as a percentage and reflects the overall performance of investments, taking into account price variations, dividends, interest and other income.

Simply put, the rate of return measures the profit or loss generated by an investment in relation to its initial cost. It can be used to assess the efficiency of an investment, and to make comparisons between different types of assets or portfolios.

It is important to distinguish several types of return. Nominal return represents the gross gain on an investment without taking inflation into account. Real return, on the other hand, adjusts this gain for inflation, providing a more accurate picture of the purchasing power of realized gains. It's also crucial to differentiate annualized return from cumulative return. Cumulative return measures the total performance of an investment over a given period, while annualized return expresses this performance as an average annual growth rate, making it easier to compare investments over different periods.

Methods of calculating rate of return

To assess the performance of your portfolio, several methods of calculating the rate of return can be used. Each method has its own specificities and applies to different contexts.

Simple yield

Simple yield is the most straightforward and easy-to-understand calculation method. It measures the percentage change in value of an investment over a given period. The simple return formula is: (Final investment value - Initial investment value) divided by Initial investment value multiplied by 100.

For example, if you invested €1,000 in an asset that is now worth €1,200, the simple return is : (1200€ - 1000€) / 1000€ x 100 = 20%.

This method is useful for a quick evaluation, but does not take into account intermediate contributions or withdrawals of funds.

Time-Weighted Return

Time-Weighted Return (TWR) is a method that neutralizes the impact of external cash flows (inflows and outflows). It is particularly useful for assessing portfolio manager performance independently of investors' investment decisions.

TWR is calculated by dividing the total investment period into sub-periods, calculating the return for each sub-period, and then compounding these returns.

Money-Weighted Return

Money-Weighted Return (MWR), or Internal Rate of Return (IRR), takes into account the timing and amount of cash flows. It measures overall portfolio performance, taking into account inflows and outflows.

MWR is calculated by finding the discount rate that equates the present value of future cash flows with the initial value of the investment.

Annualized return

The annualized return converts the total return over a given period into an average annual growth rate. This makes it easy to compare investments made over different periods.

Each method of calculating the rate of return has its advantages and disadvantages. Simple yield is easy to calculate and useful for a quick assessment, but it does not take into account intermediate cash flows. Time-weighted return is ideal for assessing a portfolio manager's performance independently of inflows and outflows, while value-weighted return better reflects overall portfolio performance by taking these cash flows into account. Finally, annualized returns enable performance over different periods to be compared in a standardized way.

Factors to consider when calculating

When calculating your portfolio's rate of return, it's crucial to consider a number of factors to obtain an accurate and comprehensive assessment.

Dividends and interest

Dividends and interest form an important part of the total return on many investments. Ignoring this income can lead to a significant underestimation of your portfolio's return. For an accurate assessment, it is essential to include all dividend and interest payments received during the calculation period. This can be done by adding these amounts to the final investment values, or by reinvesting them in the yield calculation.

Fees and expenses

The fees and expenses associated with managing your portfolio can significantly affect your net return. These include fund management fees, brokerage commissions, transaction fees and other costs. To calculate a net rate of return, it is essential to subtract all fees and charges from total earnings. For example, if you made a gross gain of €1,000, but paid €100 in fees, your net gain will be €900, which must be taken into account when calculating the rate of return.

Inflation

Inflation erodes the purchasing power of your investment gains. To get a realistic picture of your portfolio's growth in terms of purchasing power, it's important to calculate the real return. This is done by adjusting the nominal return for inflation. For example, if the nominal return on your portfolio is 5% and inflation is 2%, the real return is approximately 3%.

Reinvestment of gains

Reinvesting earnings, such as dividends and interest, can have a significant impact on your portfolio's total return, thanks to the compounding effect. When these gains are reinvested, they themselves generate returns, increasing overall returns over the long term. It is therefore crucial to take these reinvestments into account when calculating the rate of return. For example, if you reinvest a €50 dividend in an asset that is growing by 10%, this reinvested dividend will generate an additional gain of €5.

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