Return Calculations
It is important to be able calculate the return of an investment to determine if your committed funds are working hard enough (profitable) for you to obtain your desired goal.
These calculations are useful because they let you know quickly if your investment is up or down and by how much but they however exclude the time parameter and the impact of inflation.
We will cover more on this in later sections.
1. Net Returns
2. Return On Investment (ROI)
3. Real Rate of Return
1. Net Return
Formula:
Current Price – Purchase Price
Example:
You bought shares for 1000 (Purchase Price) and they are worth 1350 (Current Price) today.
Calculation:
1350 – 1000 = 350
The investment grew by 350.
2. Return on Investment (ROI)
Return On Investment (ROI) is the percentage change between purchase price and current price.
Formula:
((Current Price – Purchase Price) / Purchase Price) x 100
Calculation:
((1350 – 1000) / 1000) x 100 = 35%
The investment grew by 35%.
The example above shows a great return of 35% but if that return happened over a 10 year period you are looking at a 3.5% growth rate per year. Not so great anymore. Time is not taken into account in this calculation but useful nonetheless.
3. Real Rate of Return
The Real Rate of Return is used to determine the effective return of an investment after adjusting for inflation.
Inflation devalues your purchasing power. In short, today you will be able to purchase something for 100 but in a years’ time prices have highly likely gone up and you will not be able to buy the same item for a 100.
Formula:
1 + Interest Rate
RRR = —————————– – 1
1 + Inflation Rate
Example:
Interest Rate: 8% (100 / 8 = 0.08))
Inflation rate or CPI: 5% (100 / 5 = 0.05)
Calculation:
1 + 0.08
RRR = ——————– – 1 = 0.029
1 + 0.05
To get to a percentage simply multiply by 100. 0.029 x 100 = 2.9%
In this example your investment grew by 2.9% in real terms.
