The Handbook of Financial Instruments

Chapter 3 Calculating Investment Returns

Bruce Feibel

Director Performance Measurement Technology Eagle Investment Systems

After investment objectives have been set, strategy determined, assets allocated, and trades are made, the next task is to value the portfolio and begin the process of performance measurement. Whether an investor makes his own investing decisions or delegates this duty to advisors, all parties are interested in calculating and weighing the results. The first stage in the performance measurement process is to compute a return, which is the income and profit earned on the capital that the investor places at risk in the investment.

Suppose $100 is invested in a fund and the fund subsequently increases in value such that the investor receives $130 back. What was the return on this investment? The investor gained $30. Taking this dollar return and dividing it by the $100 invested, and multiplying the decimal result 0.3 by 100 gives us the return expressed as a percentage; that is, 30%.

A rate of return is the gain received from an investment over a period of time expressed as a percentage. Returns are a ratio relating how much was gained given how much was risked. We interpret a 30% return as a gain over the period equal to almost 1/3 of the original $100 invested.

Although it appears that no special knowledge of investments is required to calculate and interpret rates of return, several complications make the subject worthy of further investigation:

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