Making investments is a strategic move that requires careful consideration, research, and understanding. With a plethora of investment types on the market, what distinguishes one from the other? Absolute Return and Annualised Return are two important measures that can help an investor assess the performance of their investment.
Absolute return and annualised return are distinctive approaches to gauge the returns on your investment, creating different perspectives on the profits earned. Understanding the difference between absolute return vs annualised return can guide you in making an informed decision on which type of investment is ideal for you.
Absolute return – Definition
The absolute return is the gain or loss that an investment makes over a certain period. It’s essentially the percentage change in the investment value. Unlike relative returns, absolute returns are not benchmarked against any index. This means the return is not compared to any predefined market index.
The measure is quite simple and straightforward. Its formula is:
Absolute Return = ((Current Value – Initial Value) / Initial Value) * 100
For instance, if you bought the units of ‘XYZ’ Mutual fund for ₹1,00,000 a year ago, and its current value is ₹1,20,000, then, the absolute return will be:
= ((₹1,20,000 – ₹1,00,000) / ₹1,00,000) * 100
= 20%
This indicates that your mutual fund investment has grown by 20% during the investment period—in this case, one year.
See also: bajaj large and mid cap fund
Annualised Return – Definition
Annualised returns, on the other hand, are more complex but provide a broader perspective of an investment’s performance. It’s the average amount of money earned by an investment each year over a given time period. Annualised return is essential in comparing the return from investments that have different durations.
The formula for an annualised return is:
Annualised Return = ((1 + Absolute return) ^ (1/ number of years)) -1
Suppose, the absolute return from a ‘XYZ’ mutual fund scheme after three years is 47%; then, the annualised return would be:
= ((1+47/100)^(1/3))–1
=13.98%
Annualised return figures are usually compounded, meaning they feature the magical compounding effect that appreciates the invested value.
Comparing absolute return vs annualised return, it can be said that absolute returns are relatively simpler to calculate, yet they do not consider the length of the investment period. On the other hand, annualised returns take into account the investment duration, offering a more optimal understanding of the investment growth over the years.
See Also:sbi innovative opportunities fund
Depicting this via HDFC Mutual Fund, one of the leading Asset Management companies in India, we notice that they display both Absolute returns and Compounded Annualised returns on their portal. This offers investors a comprehensive view of the fund’s performance — assisting them in making informed decisions.
Before making a decision to invest, it is necessary to gauge all the pros and cons. Trading in any financial market, including the Indian financial market, involves a high level of risk. It is to be understood that both absolute and annualised returns are historical in nature. Past performance may or may not be sustained in the future. Thus, it is advisable to thoroughly understand the investments, their requirement of time horizon, their ability to meet your financial objectives, and their levels of risk. Consulting with a market professional can also be beneficial.
