Whether you invest in mutual funds, the stock market, fixed deposits or any other financial product, measuring investment returns is an essential step of the investing process. Measuring returns helps you evaluate different investment options. You can then decide whether you should skip an investment opportunity, continue investing in it or terminate it.
Here, in this guide, we share with you simple ways to measure investment returns.
What is the return on investment?
Shortly referred to as ROI, return on investment is a numerical indicator of the performance of your financial portfolio. It's applicable for both fixed-income investment products like FDs, RDs, and PPF as well as market-based investment products like mutual funds and stocks.
The ROI is a comparison indicator that helps you understand the returns gained from an investment so that you can alter your financial portfolio accordingly.
Few Factors to know before Measuring Investment Returns
ROI can either be Positive or Negative
The return on investment (ROI) is usually represented as a ratio or percentage. The ROI shows the current value of the investment compared with the initial price you paid for it. ROI can either be positive or negative.
Let us assume that you purchased a share for Rs. 100. If you sell the stock at Rs. 120, the ROI is 20%. On the other hand, if you can sell it only for Rs. 80, the ROI is -20%.
You need to consider the Total Cost of Purchase
Besides the purchase price, investments usually incur other costs like brokerage fees, commissions, etc. While calculating the ROI, you have to consider the total cost and not just the purchase price of the investment.
Include the “hidden” income you Earn from It
Let's say, you have purchased a stock that pays dividends every quarter. While calculating the investment returns, you have to include the bonuses received in the current cost of the stock for measuring ROI accurately.
How to measure the returns of investment?
There are plenty of formulae that help you calculate the ROI of an investment. Here, we introduce a straightforward method for measuring investment returns.
Investment Returns = (Total gains from the investment – Investment Costs) / Investment Costs
It’s usually represented as a ratio or percentage. Higher the value of ROI, higher are the gains you have derived from an investment.
Sample ROI Calculation
Let’s assume that you have invested a lump-sum of Rs. 50,000 in an equity-oriented mutual fund. The value of the fund after three years is Rs. 75,000. As per the formula mentioned above,
ROI = (75,000 – 50,000) / 50,000 = 0.5 = 50%
The return from this investment is a good 50%.
Calculating Different Types of Returns
As an investor, it pays to understand the different types of returns so that you can choose the best investment option. Here, we look at some different methods of measuring investment returns so that you can choose the right approach for your specific needs.
Absolute returns calculate the amount you have gained on your principal investments. Let's state that you have invested a principal of Rs. 1 lakh as fixed deposits. The value increases to Rs. 1.5 lakh after five years. Then, the absolute return is 50% on the principal.
Price return is simply the measurement of the difference between the initial and the final value of the investment. It doesn't include the dividend returns, gains from interest and other additional benefits.
For instance, let's assume that you invest in a mutual fund scheme. You have purchased NAVs valued at Rs. 10 per unit. After a year, the value of the NAV increases to Rs. 11. Then, the price returns are 10%. Note that this calculation doesn't consider the other mutual fund expenses like fund house fee, etc.
It measures the investment returns, including the dividends, interest generated, etc. It's used for measuring the returns of investment for mutual funds that offer growth options and other similar investment products.
While absolute returns are helpful, it doesn't give the complete picture, as it doesn't consider the time you've held the investment product. Let's say that you have purchased stock worth Rs. 200. The value of the share after one year is Rs. 220. That is a 10% increase. However, if the stock's value increases to Rs. 220 after holding it for ten years, then the ROI is not so good.
This is where annualised returns on investments come into the picture. The formula for annualised ROI is,
Annualised ROI = (Current value of the investment/cost of the investment) * (1/no. of years held) – 1
Let’s assume that you have invested a lump-sum of Rs. 2,50,000 in an equity-oriented mutual fund. The value of the fund after three years is Rs. 3,00,000. As per the formula mentioned above,
ROI = (3,00,000 – 2,50,000) / 2,50,000 = 0.2 = 20%
The absolute return from this investment is a good 20%. Now, let's calculate the annualised return of this investment, after holding it for three years.
Annualised ROI = (3,00,000 – 2,50,000) (1/3) – 1 = 0.063 = 6.3%
Addtional Reading: Investments with Tax Benefits
Use a Return of Investment Calculator to Simplify the Calculations
If you're not a fan of doing lengthy mathematical calculations, you can make use of online calculators that help with investment returns. These calculators are quite easy to use. All you have to do is provide details of your investment like – purchase price, current value, number of years held. The calculator then computes both absolute returns and annualised returns for you within a few seconds.
Make sure to measure and track returns from your investments periodically, so that you can make the necessary changes to your portfolio accordingly.