How to Calculate Portfolio Returns?

Growing hard-earned savings into long-term wealth is tricky without knowing what works best, right? However, regularly measuring portfolio returns can help us determine which mix of stocks, mutual funds, and other holdings perform well. 

In this article, we will learn the simple ways to consider asset efficiency so that we can make our money grow smarter, even without complex finance skills.

Understanding portfolio returns fundamentally

An investment portfolio is a collection of various assets such as stocks, bonds, ETFs, and alternatives that individuals put together based on their risk appetite, goals, and liquidity needs with the aim of creating wealth. The portfolio return metric measures the combined appreciation of the holdings mix, indicating how effective it is towards increasing capital.

Why measure portfolio returns routinely? 

In evaluating financial performance, it is essential to track portfolio returns just as businesses monitor their sales and revenue. With consistent measurement, it’s easier to determine if progress is being made and to make necessary adjustments.

Regular returns review assists better decision capabilities around aspects like:  

– Evaluating asset mix effectiveness 

– Comparing instruments/class attractiveness

– Benchmarking fund manager alpha contributions  

– Reconfiguring concentrations, etc.

Key aspects to consider when calculating returns

Some vital considerations around portfolio returns calculation:  

a. Time horizons

It is crucial to maintain consistency while calculating investment returns and to have a uniform time frame that transits from months to years as per individual preferences. It is also equally critical to ensure that the measurement duration is consistent across all constituents. For example, if a 90-day window is used as the measurement logic, then both equity and debt contributions must follow the same standardised intervals.

b. Data proportionality

For achieving maximum returns on your Portfolio, it’s essential to ensure that all the underlying assets have the same duration. This will enable proportional precision and optimise your investment outcomes.

Returns calculation fundamentals

Two fundamental components make portfolio return calculation simple:

– Periodic percentage returns from individual holdings  

– Respective value weightage percentages

When combined, the aggregate reflects the overall returns of the Portfolio for identical periods.

Returns computation by asset class

However, calculation methodologies differ across instruments:

• Equities – {(Current Price – Purchase Price) + Dividends} / Purchase Price 
• Bonds – {[(Maturity Value – Purchase Price) + Coupons] / Purchase Price}
• Others – Respective valuation principles apply 

Finding asset value proportion in the portfolio

This requires:  

• Individual Asset Value / Overall Portfolio Current Value

Easily derived percentages indicating exact composition.

Portfolio return formula  

(Portfolio Returns) Rp = ∑ni=1 wi ri

Where, 

W – Asset weight %  

R – Respective asset returns over the uniform timeline

Thus, combining periodic performance and proportional mix calculates portfolio returns.

Detailed walkthrough of portfolio returns calculation 

The essential steps that make it easier to measure portfolio returns:

Step 1 – Fix a uniform timeline for computation spanning the chosen duration

Step 2 – Calculate periodic returns for individual portfolio assets over this duration 

Step 3 – Determine the current proportional weights of each asset by Value

Step 4 – Multiply respective returns with asset weights 

Step 5 – Summate weighted returns to derive aggregate portfolio-level score

Portfolio returns computation example

Consider the expected return of portfolio of a ₹7 lakh portfolio with 40% equity and 60% debt allocation: 

• Equity (₹2 lakhs invested):
• Current Price – ₹2.2 lakhs   
• Returns = (2.2 – 2)/2 = 10%

Debt Fund (₹3 lakhs invested):  

• Current Value – ₹3.36 lakhs
• Returns = (3.36 – 3)/3 = 12%
• Portfolio Returns = (10% x 40%) + (12% x 60%) = 11.2%  

Thus, the expected rate of return formula constitutes the sum of individual asset class contributions weighted by portfolio mix.

Portfolio returns computation methods

Method 1

Holdings:

• Equity 1 – ₹3 lakhs  
• Equity 2 – ₹4 lakhs   
• Total Portfolio: ₹10 lakhs

Quarterly Returns:

• Equity 1 – 5% 
• Equity 2 – 8%
• Equity 1 Weight = 3/10 = 30%
• Equity 2 Weight = 4/10 = 40%
• Portfolio Returns = (5% x 30%) + (8% x 40%) = 6.6%

Method 2

Holdings:

• REITs – ₹2 lakhs   
• Bonds – ₹3 lakhs  
• Gold ETFs – ₹1 lakh  
• Total Portfolio: ₹6 lakhs

Annual Returns: 

• REITs – 11%   
• Bonds – 9% 
• Gold ETFs – 7%  
• REITs Weight = 2/6 = 33%
• Bonds Weight = 3/6 = 50%
• Gold ETFs Weight = 1/6 = 17%

Portfolio Returns = (11% x 33%) + (9% x 50%) + (7% x 17%) = 9.5%

By utilising different scenarios, we can showcase how realistic calculations of the holdings mix can be applied effectively.

Summarising portfolio returns measurement utility

Ensuring the availability of metrics is crucial for guiding critical aspects such as:

– Asset category rebalancing requirements  

– Concentration and risk calibration  

– Fund manager selections through equivalent standards

– Insurance/annuity quantum optimisation  

Importance of adjusting intermediate cash flows

When additional investments occur amidst the returns measurement window, the interim infusion must not distort calculations. Tools like the Modified Dietz method accurately nullify the effects of external cash flows on periodic return capture.

Annualising multi-period portfolio returns   

For proportionate comparison, longer duration returns require annualisation using:

• Annualised Returns = [(1+R1)*(1+R2)] ^ (1/years) – 1

Where,

R1 and R2 represent the returns that occur periodically across multiple years.

This normalises the expected return formula to a consistent one-year criterion.

Future portfolio performance forecasting

Historic returns can be used to predict future expectations.

• Expected Returns = Current Returns + Future Income Adjustments

However, multiple uncertainties challenge the accuracy of predictive models. Continual empirical validation becomes necessary for optimal strategy calibration.

Why regular measurement holds significance  

Regularly examining the returns of one’s investment portfolio is similar to conducting health check-ups using diagnostic indicators. It helps investors evaluate their investment progress and make informed decisions regarding their future investments:

– Evaluate holdings mix rebalancing openings  

– Assess asset category outperformance consistency

– Gauge fund selection success  

– Keep risk-adjusted metrics continually optimised

Conclusion

Investors can improve their decision-making by analysing their investment portfolio’s performance over time. This way, they can make more informed decisions based on actual data instead of taking a blind approach. Regularly reviewing your Portfolio’s scorecard is crucial for generating wealth through smart investments, so be sure to stay aware of your returns. By embracing this approach, you can make better choices on your journey towards building long-term financial security.

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