The two kinds of returns that investors most frequently use are absolute and relative returns. Absolute return tells you how much your investment has grown in percentage terms. Relative return tells you how this growth compares to a benchmark. The selection of an appropriate benchmark is critical, as comparing your performance against the wrong yardstick could give highly misleading results.
Relative Return Formula
Star by calculating your absolute percentage return, which equals: (sales proceeds-original investment)/original investment_100. Say, you invested $500 at the beginning of the year, which has grown to $540 in 12 months. Your absolute return equals ($540-$500)/$500_100, or 8 percent. To arrive at your relative return subtract the percentage gain or loss of the benchmark which you set out to beat. Say your benchmark is the S&P500 index, and the S&P advanced by 6 percent during the same period. Your relative return equals 8-6 percent, for a 2 percent return. So your excess return relative to the index is 2 percent.
Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.