Investment word of the day: Whenever you make an investment, you will be curious to know how your money is performing over time. There are several measures to check the performance of your investment. One such measure is absolute return.
What is absolute return?
Absolute return or total return is a measure used to estimate gains or losses made on an investment without comparing it to any benchmark or index. It shows the actual profit or loss generated over a period of time, independent of any other factors.
Absolute returns do not depend on any external comparison metric, unlike relative returns, which show an investment’s performance by considering market indices.
How do you calculate absolute return?
Absolute return is expressed in percentage. The formula to calculate absolute return is – [(Current Value – Initial Investment) / Initial Investment] * 100.
Why are absolute returns important for an investor?
“Absolute returns are of great importance to investors who look for consistent growth, capital preservation, and wealth accumulation over time. Regardless if the market is doing good or bad, an investor’s main focus is getting returns, therefore making absolute performance a more useful metric than relative comparisons,” according to Bharat Mundada, Director, Mundada Finserve Pvt Ltd.
“Even in times of market volatility, absolute returns are focused on by investment strategies like hedge funds, private equity, and the alternative asset class in order to generate steady growth,” he added.
Absolute returns help investors make sound decisions by evaluating the success of their portfolio without being influenced by overall market movements.
For example, if the market declines 10 per cent and a portfolio declines only 5 per cent, a relative return approach may cause success. In reality, the portfolio still lost value in absolute terms.
This measure is specifically beneficial for conservative investors.
“In risk management, absolute returns also prove to be crucial. Investors focused on absolute performance will often adopt diversified strategies with bonds, real estate, and other instruments to lessen the impact of volatility. This strategy is especially helpful for conservative investors or those close to retiring who want to protect their wealth instead of beating the market,” according to Mundada.
In conclusion, absolute returns provide a clear and accurate measure of investment performance independent of benchmark indices. Estimating absolute returns will help investors to create a strong portfolio, even in fluctuating market conditions.