How to Calculate Your Portfolio’s Investment Returns

An investor’s main goal is to make money. Although you can’t predict how your investment portfolio will perform, there are several metrics that investors can use to calculate a realistic estimate of future growth.

Not only do investors need to consider the expected gains of each asset, they also have to consider factors such as downside risk, market conditions, and the length of time it will take for each investment to realize returns. They also need to consider opportunity costs: an asset with high potential returns might seem less attractive, if the same money can be spent more profitably on other investments.

Calculating Returns for a Single Investment

The next step is learning to calculate the return on investment (ROI) for each asset. This metric can quantitatively measure how effectively a given asset is putting your money to work.

The ROI of a single investment is calculated by dividing the net price gain from holding the asset by the asset’s original cost. The cost of an asset includes not only the purchase price, but also any commissions, management fees, or other expenses associated with the acquisition. The resulting fraction represents the gain in value as a percentage of the asset’s price.

Although it’s not a perfect science, this is a crude gauge of how effective an investment performs relative to an entire portfolio.

Calculating Returns for an Entire Portfolio

As mentioned above, there are uncertainties that come with investing, so you won’t necessarily be able to predict how much money you’ll make—or whether you’ll make any at all. After all, there are market forces at play that can impact the performance of any asset, including economic factors, political forces, market sentiment, and even corporate actions. But that doesn’t mean you shouldn’t work out the figures.

Working out the returns on individual investments can be a very exhaustive feat especially if you have your money spread across different investment vehicles that are maintained by a variety of different firms and institutions.

The first step is to list each type of asset in a spreadsheet, along with their calculated ROI, and any dividends, cash flows, management fees, and other figures relevant to the cost or returns of those assets. You’ll need to know the following:

• The total cost of each investment including any fees and commissions
• The historical returns of each investment
• The portfolio weight of each investment, represented as a percentage of the portfolio’s total value.

The last two sets of figures can be used in a simple way to estimate portfolio returns: simply multiply the the ROI of each asset by its portfolio weight. The sum of these figures is the portfolio’s estimated returns.

Other Factors

While the above is a popular and simple method of estimating portfolio returns, it does not reflect other important factors, such as the holding period for each asset or the additional returns from bond payments or stock dividends.

In order to account for these factors, you’ll want to take a few things into consideration. The first thing is to define the time period over which you want to calculate returns—daily, weekly, monthly, quarterly, or annually. You also need to strike a net asset value (NAV) of each position in each portfolio for the time periods and note any cash flows, if applicable.

Holding Period Return

Once you define your time periods and sum up the portfolio NAV, you can start making your calculations. The simplest way to calculate a basic return is called the holding period return.

Here’s the formula to calculate the holding period return:

• HPR = Income + (End of Period Value – Initial Value) ÷ Initial Value

This return/yield is a useful tool to compare returns on investments held for different periods of time. It simply calculates the percentage difference from period to period of the total portfolio NAV and includes income from dividends or interest. In essence, it’s the total return from holding a portfolio of assets—or a singular asset—over a specific period of time.

Adjusting for Cash Flows

You will need to adjust for the timing and amount of cash flows if money was deposited or withdrawn from your portfolio(s). So if you deposited $100 in your account mid-month, the portfolio end-of-month NAV has an additional $100 that was not due to investment returns when you calculate a monthly return. This can be adjusted using various calculations, depending on the circumstances.

The modified Dietz method is a popular formula to adjust for cash flows. Using an internal rate of return (IRR) calculation with a financial calculator is also an effective way to adjust returns for cash flows. IRR is a discount rate that makes the net present value zero. It is used to measure the potential profitability of an investment.

Annualizing Returns

A common practice is to annualize returns for multi-period returns. This is done to make the returns more comparable across other portfolios or potential investments. It allows for a common denominator when comparing returns.

An annualized return is a geometric average of the amount of money an investment earns each year. It shows what could have been earned over a period of time if the returns had been compounded. The annualized return does not give an indication of volatility experienced during the corresponding time period. That volatility can be better measured using standard deviation, which measures how data is dispersed relative to its mean.

An Example of Calculating Portfolio Returns

The sum total of the positions in a brokerage account is $1,000 at the beginning of the year and $1,350 at the end of the year. There was a dividend paid on June 30. The account owner deposited $100 on March 31. The return for the year is 16.3% after adjusting for the $100 cash flow into the portfolio one-quarter of the way through the year.