Investing is an agile world, it is dynamic, and constantly evolving, hence to keep pace with ever-changing environment, you need to have the right approach to gauge return on investments, which lead you to earn better.
When you have the right piece of information, you can outperform your peers, the market, and take the right decisions, that eventually result in success. The right information is essential, be it winning of elections or finding the right direction in life as well on lost roads and if applied in the right manner, works wonder in managing investments.
Investing is an agile world, it is dynamic, and constantly evolving, hence to keep pace with ever-changing environment, you need to have the right approach to gauge return on investments, which lead you to earn better. Who doesn't want his/her portfolio to appreciate? But are you measuring your investment returns in the right way? Selection of the right investment technique is the first step, but to outperform, one must keep a tab on his investment regularly. Are these returns enough to achieve your goals, does it require any modifications? These and many such questions can be answered if correct evaluation tools are used. Your portfolio can have investments that are lagging or some that have gotten wrong and therefore require a closer look. Evaluation of your investment returns in the right way will lead you to take a decision as to which investment you should hold, in which to increase your allocation and which to eliminate. A right assessment of your portfolio return will help you decide the next move.
One must consider the following points to adequately measure the portfolio return:
Know Your Actual Returns: The simple math of calculating returns is "Total Realisation less Total Cost", but the catch is, you must understand what is your actual realisation and actual cost? Accretion in the price could be misleading as it may show you the half picture, the net return is an accurate way to see the whole. So let's understand the entire concept.
1. Total Realisation - Total realisation means what you received from your investments not only at the time of its sale but also during the time you are holding it. For example, if you own a stock at Rs. 100, received a dividend of Rs 3, and sold it afterwards for Rs. 110 then what is your total realisation?
The total realisation is = Rs. 113 (110+3)
The net returns of the investor are Rs. 13 after considering dividend; whereas if the dividend is not taken then the return slips from 13% to 10%.
If one does not take dividends, bonuses, splits into account, then his/her return calculation would be misleading, which will lead him/her to a wrong decision. The investors should understand the importance of including all the receipts relating to investment, as only this would help one whether the investment decision fulfilled the goals or not.
2. Total cost - To know the actual and complete cost, one needs to know how much one has paid to get the desired income. The total cost here means to include all your costs relating to buying the investment. If the investment has been made in realty, then the stamp duty and registration charges should be included and if one has invested in stocks, he/she must add the STT, brokerage and other charges paid.
Like in the following example taken from our portal InvestOnline.in’s Portfolio Viewer Page where the ‘Net Invested Cost’ is the investment less dividends or redemptions.
Don't Forget Giving It The Tax Effect: Tax reduces your actual returns, it changes your investment decision. Every time you gain, the government is always there to claim its share. Shouldn't it be part of your calculation? After giving the tax effect only, you get to know how much you are left with. Tax is complicated, and it is different for every investment instrument, which makes it important to take into the equation.
For example, Rahul invested Rs. 1,000 in FD when he is in the 30% tax bracket. On FD returns, he has to pay taxes even if he is not pocketing its profits. At the same time, Shreya invested the same amount in debt funds for more than 3 years. In those 3 years she is not required to pay tax on any notional gains and will only be liable to pay taxes once she withdraws the investment after taking indexation benefit due to investing in a long term investment instrument. Both investors are earning an appreciation of 8.5% p.a.
As a whole, both the investments seem to be producing the same returns, but even if we use the simple interest calculation, the returns are different.
Rahul's total returns after taxation = Rs. 178.5 [(1000*8.5%)*3]= 255-(255*.30)
Shreya's total returns after taxation = Rs. 216.1
Shreya has Rs. 37.6 extra return than Rahul, it may not look like a big difference, but taking the same gain in %, Shreya has earned 21% more than Rahul.
Indexation works better when invested for a long time. Taking 5 years of indexation at the tax rate of 20%, the indexation will reduce the tax rate to 13% and if the investment period increased by one more year, the tax rate would further slump to 10%.
So, next time when you are calculating your returns, give it a tinge of tax and calculate your after-tax return because this is what matters. After all, you never want your head high on the cloud due to large pre-tax returns.
The Benchmark Compariso: Comparison is good, it is how you know whether you are lagging to leading. The comparison tells you where you should invest and where to divest. The comparison to the benchmark shows you whether your investments are gaining because of their own excellence or market is the one who is driving the performance. An investor investing in debt funds should compare its returns with Bond yields, an investor investing in stocks should compare it with NIFTY or SENSEX benchmark. An investment return of 12% in 6 months is lucrative, but what if the benchmark index grew by more than 15%, you would consider yourself cheated, due to lagging as you are taking a similar risk in comparison to the broader market but pocketing lower returns.
An investment in the top 50 companies would require a comparison to NIFTY 50, a broader investment would require NIFTY 200 and so on, but what if a portfolio consists large cap, mid cap and small cap companies at the same time? Then the comparison can't be done by a single index, it should be done by taking weighted average returns.
For example, Rahul has invested in large, mid and small cap companies with 50%, 25% and 25% allocation respectively for 5 years. The returns provided by the respective benchmarks are Nifty 50 - 50%, Nifty Midcap 100 - 43% and Nifty Smallcap 100 - 34%.
Weighted average return of the benchmark = (50%*.50)+(43%*.25)+(34%*.25) = 44%
If Rahul's portfolio is giving any lesser return than 44% than his investment is lagging the benchmark and assuming the other things constant, needs some changes to cope-up with the benchmark returns.
The Risk Adjustment: Risk and returns go hand in hand, but a good investment gives higher returns with potentially lower risk. If you too have the same investment strategy, viz. increasing your returns with moderate risk, then you shall evaluate the risks and returns of your portfolio regularly. A non-consideration of risk may push your portfolio risk to beyond the acceptable levels.
An investment in FD gives 8% returns with low risk, a AAA corporate bond gives 9% as the risk is high in comparison to FD, and an investor in general equity expects 12-15% gains as the risk is even higher in comparison to both. Rising risk demands higher returns, but what if your investment returns are the same with increased risk, this needs a regular analysis. Measuring returns and neglecting risk could mislead as it may be taken that the risk has been constant in the whole investment cycle when only the returns are surging. With growing portfolio value one must understand that risks may also rise. The portfolio returns could be the conclusion of taking higher risk and not on the merits of the portfolio holdings.
Investment returns show the brighter side, whereas measuring risks of the portfolio reveals the dark side, which is necessary to have a comprehensive view. Risk evaluation helps an investor to understand whether the risk taken is worthwhile or not, it helps the investor to reallocate its portfolio according to its risk appetite.
For risk evaluation, one must consider Standard Deviation to measure the volatility and Beta for symmetric risk.
Investment Period: Higher returns are expected for a higher investment period as the investor is releasing the alternatives of using invested money for a long time and it even exposes him/her to some risks not known while investing. An investor who is accounting returns must compare it to the investment period, and calculate whether its performance was average, above average or below average. Mere calculating returns in % to the invested capital tells you the half truth. In normal conditions, higher investment period gives higher returns. Returns and investment period should weigh on a scale and unless the return outpaces the tenure, an investment cannot be justified as good. This comparison shows that if an investor is thinking about withdrawing investment in a period like 2018 where the overall returns are lesser than the previous year, then he/she should consider staying invested till a time where the investment tenure and returns turned into his/her favour.
Consider Real Returns: Investments which grow over and above the inflation are the true investments as the otherwise would be engulfing the monetary value over the period. Returns can only be considered good when it beats inflation. Hence, to measure the true and correct yields of your investment, it is required to deduct the effect of inflation from the gains, which will provide you how much your investment has risen in the real term during the period.
For example, an investment of Rs. 1,000 is made for 5 years at an average of 8% annual return at the time when the inflation during the period was 7%.
After 5 years, the total returns would be Rs. 469.
But the real return is only Rs. 47 as the rest has been eliminated by inflation.
Hit Rate - A hit rate is a measure where a trader analyses his/her performance on not by the gains pocketed but by the % of successful transactions.
Hit Rate = (Total number of successful transaction*100) /Total number of transactions
The higher the hit rate, the better it would be for the traders. An investor with near 50% of hit rate has a very low margin. Even if the returns are higher in comparison to the losses, it could be the time for the trader to either change its trading strategy or to make some alteration in the current one. A hit rate of more than 60% is considered good.
What's the bottom line:
Selection of the investment instrument is the first step. Regular evaluation of the performance is the next. They keep your portfolio's health intact. The right methods to evaluate the performance of the returns help the investor to take an effective decision. While measuring returns on your investment, it must consider only the net returns after considering all gains, expenses and tax liabilities. Those gains shall be compared to the benchmark return while it is also required to know whether the investor is taking any unwanted risk or not for trying to reach extraordinary returns.
[Disclaimer: The author is the InvestOnline.in. The views and opinions expressed in this article are those of the author and do not necessarily reflect that of Business Television India (BTVI)