Here’s Why You Should Know How To Calculate Return On Investment

Note: This post was edited on January 12th 2018 because the graphic showing return on investment for 8 months was wrong, as pointed out by commenter NMK. I try very hard to avoid mistakes, but shit happens! Always grateful to readers who point it out. I’ll also ensure that it doesn’t happen again. Check, double check, triple check! Thank you. 

A few weeks ago,  we discussed SIPs, and the return that I had received. In today’s post, I will talk about how to calculate return on investment, and the annualised rate of return. This post is primarily about calculating returns on Mutual Funds, but these formulae will work on most other investments, as well.

Why Should I Know How To Calculate ROI?

You should know how to calculate Return On Investment, and more so, annualised Return On Investment for two reasons. The first being that you should know if your investment is doing well, and the second, to compare your investment with another.
This is especially important when you want to compare investments across different risk levels: for example, if you want to compare the return from an FD (no risk investment) to an equity Mutual Fund (high risk investment).

There are two main types of return that you should know how to calculate: Holding Period Return and Annualized Return.

Calculating Holding Period Return on Investment

The Holding Period Return is literally the return on investment for the period that you’ve held the investment.

Let’s assume you have invested Rs.1 Lakh in a Mutual Fund at an NAV of Rs.25.

You would have received 4,000 units (1,00,000/25)

The fund declares a dividend of Rs. 2 per unit, and you receive Rs. 8,000 as dividend.

Today, the NAV of the fund is Rs.30/- and consequently, the value of my investment is Rs.1,20,000/- (4000 units at an NAV of Rs.30).

What is the rate of return? Here’s how it’s calculated:

The dividend in the first formula refers to Dividend per unit, so in this case it is Rs. 2. So, my numerator is:

30-25+2 = 7

My denominator is 25. Dividing, and multiplying the result by 100, I get 28%.

Alternatively, you can use the second formula, with the absolute dividend received. The answer will be the same.

My annualised Return On Investment, however, would be different.

Calculating your Return on Investment is a lot simpler than you think! Click To Tweet

calculate return on investment

What is Annualized Return On Investment?

Annualised Return On Investment is the Return that you have received if you had held your investment for a year. You can calculate Annualized ROI irrespective of whether you’ve held your investment for 2 months or 22 months. Annualised ROI is the best tool for comparison across investments –  assume you have one Lakh to invest, and you want to compare the returns that a Mutual Fund gives, vis-a-vis a Fixed Deposit, it helps to know the annualized rate of return.

Be warned though – the returns that you receive on mutual funds, especially those with a good percentage of equity in them, are usually volatile. A Fund’s performance greatly depends on the market.

 

Calculating Annualized Rate of Return On Investment

The method of calculating Annualized Rate of Return depends on how long you have held your investment. Broadly, whether you’ve held your investment for more than a year, or less than a year.

If you’ve held your investment for less than a year, the formula is the same as calculating absolute return, but with the inclusion of ’12/n’.

Let’s go back to the first example of Rs.1,00,000 invested at an NAV of Rs.25. Now, assuming the NAV became Rs.30 in 8 months, our calculation would look like this:

Annualized Return for 8 Months

If you’ve held your investment for more than a year, then you should go for the second formula, known as the “Compounded Annual Growth Rate” method.

So, instead of 8 months, let’s assume this happened over the course of 2 years. My return would be:

Don’t Be Afraid Of Numbers!

It’s important to know how much your investment is giving you, because that is among the chief ways to know whether an investment is working in your favour, and if you should withdraw it. Formulae can seem intimidating, but they’re nothing but a bunch of letters and some punctuation. Excel or any other spreadsheet utility can help you get to the answer in a jiffy! Having a spreadsheet for your investments also helps keep track of them better.

I hope this post was useful in helping you calculate return on investments. Do let me know in the comments, what other areas of personal finance you would like to read about!

7 Comments

  1. Hey, are there any apps that you recommend for investing in MFs? There are a lot that claim to make it easy etc, but I wasn’t sure about which to use.

  2. For the same set of values, the annualized return cannot be 10.5% for a time frame of 8 months and 13.1% for a time frame of 2 years!!!
    The return of MF for less than a year works out to 42%(extrapolation) not 10.5% as per your own formula.

    • Thanks for pointing it out. I try very hard to avoid mistakes but shit happens! Grateful to readers like you who point it out. I’ll ensure that it doesn’t happen again. The post has been corrected. Apologies, and thanks again.

  3. Hi Lavanya, I just discovered your blog and I love it! A few ideas for future articles:
    1. You are about to begin working (likeI am in July) / about to shift to a new job. Whatthefinance must be done to be smart about the salary you earn? Like tips or s checklist
    2. Handbags as investment pieces. (The difference between investing in a trend piece from Les Petite Jouers v. Chanel classic flap)
    3. How to be a smart person and also a frequent flier. – Figuring our loyalty programs/credit card to airline miles etc

    Thank you!

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