Investment return rate calculation

Investment return rate (aka investment cost) can be defined as the profit or loss acquired from a particular business venture over a specific period of time. It can also be seen as the net amount of discount cash flow into a company. The return of every investment can be in the form of income/sales made by the investor.

HOW TO CALCULATE INVESTMENT RETURN RATES

They are a lot of factors to consider when it comes to calculating return rates. A major element in the calculation of the return rate is to identify the factors that best mirrors an economic reality. This method of calculation helps in the determination of how much additional cash an investor will truly have in his possession at the end of the investment period. In the case of calculating the return rates based on economic reality, the use of geometric average or compound average best fits the job.

EXAMPLE:

An investor has the outlined total returns in a period of three years

-    Year 1=30 percent

-    Year 2=20 percent

-    Year 3=10 percent

In the calculation of the geometric average, one is added to every annual return which springs 1.3, 1.2 and 1.1 respectively. These mathematical figures are then multiplied together and the result is raised to the power of 1/3 to modify based on the notion that investment returns were combined from three years.

Figuratively, this gives

(1.3)*(1.2)*(1.1) ^1/3=1.716^1/3

Lastly, in other to convert it back to percentage, one is subtracted and multiplied by one hundred. This indicated that the investor earned ((1.716)^1/3-1)/100 percent per annum for the past three years. 

DISADVANTAGES OF USING A COMMON CALCULATOR IN THE CALCULATION OF INVESTMENT RETURN RATES 

A common method used in the calculation of investment return rates is with the use of arithmetic mean which can be also called simple average. The arithmetic mean is a precise and simple to use method used in the calculation of many measurement. For example, it can be used in the calculation of the average of sunshine for a specific month, the average number of people in a gathering etc. However, an arithmetic mean is not an appropriate tool in the calculation of the average of annual returns of this nature. With reference to the above example, the simple average return on investment for the 3 years will be:

30%+20%+10%= 0.396

0.396/3=0.132=13.2%

This method of calculation does not follow economic reality meaning that the use of simple average in the calculation of is inappropriate.

In conclusion, in other for an investor to properly calculate his return on investment rates, he should properly understand the different types of input calculators and methods being used because some methods as seen above can be wrong and detrimental.

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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