Explained: Difference between absolute and annualised returns

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What is the primary ambition behind investing money? To make a profit. But one cannot initiate investments in a reckless manner with poor understanding of it’s arithmetic. To avoid potential losses, it’s important to be familiar with two of the most popular investing metrics. Performance of investment options like mutual funds is often analysed basis the returns in terms of both absolute as well annualised terms.

While annnualised return is the measure of how an investment performed over a year, absolute return is the metric of success for your over all investment. The yield generated by an investment over a certain period of time is known as ‘return.’ This is basically the percentage gain or decline in the investment’s valuation within the given timeframe.

Absolute Return

Absolute return shows the performance of the given investment regardless of the time consumed. The metric is expressed either in INR or percentage terms. However, percentages are considered far more efficient as it combines the elements of the initial investment and the return into a single digit.

To determine absolute return, one would need the initil and final Net Asset Value (NAV). The time is irrelevant here. But, absolute returns are mostly usually used to calculate returns over a term of less than one year.

Calculation of absolute return

Consider, you started off with an invested of Rs 15,000 and after 5 years, it is valued at Rs 50,000. Now the absolute return shall be (50,000/15,000)-1 =230% For mutual funds, absolute return is computed by taking into account initial NAV value and the current NAV.

Annualised Return

As the name suggests, annualised return determines the investor’s returns annually. An annualised rate of return can be calculated with a percentage value. Compound annual growth rate (CAGR) is a popular term that refers to the compounding of returns over time. It gives investors an overview of their investment’s results. However, it cannot predict the volatility.

How to calculate annualised returns?

Well, this is slightly difficult to compute. Here, ‘1’ is added to the absolute return value. Then the nth root of the number is taken (n being the time period) and finally 1 is subtracted from it to get the annualised multiplier.

It’s usually impossible to decide which investment deal is better because each investment is unique in the sense of time and return. An annualised return addresses this aspect by representing the returns in a one-year equal expression.

What should you opt for?

While absolute return is a calculation of an investment’s success in terms of how much money you’ve generated from the initial day, annualised return display how longer-term investments with different return rates produce value yearly.

As an investor, you must have a clear understanding of such concepts that are linked to your investment portfolio and give important insight.