“Yuppy! My investment has given me a return of 10%!” It sounds great but holds on first.
It will be more meaningful if we consider the time frame of investment with this return. If the return of 10% took a period of 3 years to achieve, the average return per year is about 3% only. If it took a period of 5 years, it will be only 2% p.a. If this is the case, you may find that such return does not mean much.
Money value is actually depreciated in time. The value of $100 today will be greater than the value tomorrow. The logic is very simple. If you put $100 into your savings account today and keep it until tomorrow, the bank will pay you interest. In your savings passbook, the balance value will be $100.01 based on 3.5% p.a.
Under normal circumstances, if you are a conservative investor, you may use the bank’s one-year FD rate or inflation rate to judge your investment performance. If we are able to outperform this basis, we will be able to achieve our financial objective at a faster pace. For aggressive investor, we can adopt share index as a benchmark. In short, which benchmark to be used to judge your investment performance will totally depend on your risk going to be taken.
To calculate the average yearly rate of return, the formula is:
(((1+r/100) ^ (1/n))-1)*100
where,
r = total rate of return
n=investment time frame
For example, 10% rate of return in 3 years shall be calculated as follow:
r = 10 (i.e. 10%)
n = 3 (i.e. 3 years)
Therefore, the average annual return = (((1+10/100) ^ (1/3))-1)*100 = 3.228 (i.e. 3.228% p.a.)
Happy investing.
A Random Thought on Income Growth
1 day ago
How you calculate rate of return let say t = 1 year with principle = RM a, and every month you add additional RM b, and your year end return is RM c.
ReplyDeleteWhat method you use?
Regards
V
That is a very good question.
ReplyDeleteWell, the formula I highlighted in this post can be utilized to calculate the annual rate of return for monthly investment as well.
What I do is I will divide the variable n with number of months in calculation.
First, you need to record down each and every monthly transaction carried out (date of purchase, investment amount and the number of units or share of your investment). Add up every investment amount and you will get your total investment for the year. We need this for later use.
Next, by the end of the year, get the market value of each monthly transaction.
Now, use the formula highlighted in this post but change the variable n into n/12 where n is number of months.
For example, Say you initial investment on 1st Jan was $100 and it worth $115 by the end of the year. Therefore, its nominal return is 15% and its effective annual return is (((1+15/100) ^ (1/(12/12)))-1)*100 = 15%; Move on to your next investment amount on 1st February, say, $110 and it worth $120 by the end of the year. As the total investment period was only 11 months, its effective annual return will be (((1+9/100) ^ (1/(11/12)))-1)*100 = 9.86%; The calculation shall go on until your very last investment amount.
After that, divide each month’s transaction amount over your total investment amount for the year which you calculated earlier. By timing up this value with respective effective annual rate of return of every month, you will get weighted average annual rate of return. By adding up all weighted average annual rate of return and you will have your total effective rate of return.
For example, say the unit you purchase throughout the year worth $1.12/unit by 31st December and you monthly detail purchase is as follow:
Date Investment Unit Price # of Unit WA RR EAR WARR
1/1 $100 $1.00 100 7.5% 12% 12% 0.9%
1/2 $110 $1.01 108 8.3% 11% 12% 1.0%
1/3 $105 $0.99 106 7.9% 13% 16% 1.3%
1/4 $100 $0.98 102 7.5% 14% 19% 1.5%
1/5 $100 $1.00 100 7.5% 12% 19% 1.4%
1/6 $120 $1.03 117 9.1% 9% 15% 1.4%
1/7 $110 $1.05 105 8.3% 7% 14% 1.1%
1/8 $110 $1.08 102 8.3% 4% 9% 0.8%
1/9 $110 $1.07 103 8.3% 5% 15% 1.2%
1/10 $115 $1.10 105 8.7% 2% 7% 0.6%
1/11 $125 $1.11 113 9.4% 1% 6% 0.5%
1/12 $120 $1.08 111 9.2% 1% 11% 1.0%
Total $1,325 $1.04 1,270 100% 8% 12.7%
Note:
WA: Weighted average
RR: Rate of Return
EARR: Effective Annual Rate of Return
WARR: Weighted Average Rate of Return
Therefore, your annual effect rate of return is 12.7%.
Do let me know should you need further clarification.