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 didn’t 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, let’s 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)*

(ect….)) ^ 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.

# Calculating your REAL Return

October 26th, 2006 at 07:06 pm

October 26th, 2006 at 09:05 pm

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?

October 26th, 2006 at 09:13 pm

October 26th, 2006 at 11:02 pm

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.

October 29th, 2006 at 02:54 pm

February 26th, 2007 at 10:08 pm