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Calculating your REAL Return

October 26th, 2006 at 07:06 pm

Let me just start off with an example.

You have five years of return data from your portfolio.

Years/Returns

1- 10%

2- 18%

3- 21%

4- -3%

5- 17%

The way most people calculate their returns is to add all of them up and divide by the amount of years. Your average annual return would be 12.6% ((10+18+21+ (-3) +17)/5) =12.6).

This seems like the correct answer right? Not really. Let me show you another example so you can see the flaw using this kind of equation.

You purchased a mutual or stock at $100.00 per unit and it does not pay any dividends. The first year it goes down to $50.00 per unit. The second year it doubles up to $100.00 per unit. You would assume that you didnít make or lose any money right? Well wrong again. Using the same equation your annual return would be 25%!

Years/Returns

1- 50%

2- 100%

(-50+100)/2= 25%

Now that you see why the conventional way of finding your return is flawed and delivers false returns, letís view the real way to calculate your return.

1st. You have to change all your returns to decimals. After that use this equation to find your real return.

((1 + (1st yr. return)*

(1+ (2nd yr. return)*

(1+ (3rd yr return)*

(ectÖ.)) ^ 1/ (number of years)-1

We will use the information from the first example.

((1+.10)*(1+.18)*(1+.21)*(1-.03)

*(1+.17)) ^ 1/5=.122 *100% = 12.2%

I know this equation involves a calculator and an extra one minute of work, but it shows you the real return on your investments which is crucial.

5 Responses to “ Calculating your REAL Return”

  1. LuckyRobin Says:

    You do like the math, don't you? Embarrassment}

    So, for example, would this be the way it is calculated on my Vanguard statement or would they be doing it the first way you mentioned?

  2. JRBeaudry Says:

    Most of the time, when itís an annual summary itís a totally different calculation then the example I used in my examples. If they were to give you more than one year summary like 4 or 5 years. Then yes they should be doing it this way. The funds I have only provide a yearly summary so I have to do the match myself Wink

  3. yummy64 Says:

    Price when you bought it and price now. To me those are the only two the matters. The teeter totter in the middle is just illusions.

    So to me its just price bought, price now and time held that matter. The rest is illusion.

    And I'm pretty sure some instructor I had is feeling a sharp stabbing feeling.. LOL.

  4. Broken Arrow Says:

    It's great to see it written out and explained, though I'm glad that my website just does it all for me. I'd hate to have to do it by hand. Big Grin

  5. ashley Says:

    one year ago, you bought a bond for 10,000. you received 400 interest at end of year, as well as your 10,000 principal. if inflation rate over last year was 5 percent, calculate your real return. show work.

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