Absolute Return vs Annualised Return

Many of you are curious about Absolute Return vs Annualised Return – two big ideas in finance and investing. Knowing these terms is key if you’re trying to find out the ins and outs of investments. Whether you’re just interested in investment, or a seasoned market player, this blog is made for you.

Our goal is to show the difference between Absolute Return and Annual Return. We make sure the information is not only correct but also easy to understand. Let’s explore the distinctions, importance, and uses of Absolute Return and Annual Return in your investment journey.

What is Absolute Return?

Absolute Return is the overall profit or loss an investment makes over a particular time period. It’s a straightforward measure, focusing on the actual money gained or lost, without considering the market conditions or any benchmarks. In simpler terms, it’s just the raw profit or loss figure.

Let’s break it down: Picture yourself investing in a stock or a mutual fund. After a year or two, you want to see how your investment did. Absolute return is the percentage change in its value from when you got it to when you checked it.

Absolute return answers a key question for investors: “How much money did I gain or lose?” However, despite being a clear way to assess performance, absolute return doesn’t provide the full picture, especially when comparing different investments or considering performance within market conditions. This is where annual return and other measures become important.

What is the Absolute Return Formula?

The Mathematical formula to calculate absolute returns is

Absolute Return = (Final Value – Initial Value) / Initial Value * 100%

  • Example: You invest ₹10,000 in a mutual fund. After 3 years, the investment grows to ₹15,000.
  • Absolute Return = (15,000 – 10,000) / 10,000 * 100% = 50%
  • The absolute return is 50%, indicating a 50% gain over the 3 years.

Examples of Absolute Return Mutual Funds in India

Fund NameAMC3-Year Absolute Return (%, as of Jan 2024)5-Year Absolute Return (%, as of Jan 2024)
HDFC Absolute Return FundHDFC MF18.9525.22
ICICI Prudential Absolute Return FundICICI Prudential MF16.7222.14
Axis Absolute Return FundAxis MF15.5620.17
Tata Absolute Return FundTata MF12.9817.25
(This table is for information purposes only and should not be considered as investment advice)

What is Annualised Return?

Annual Return, often called annualized return, is a key financial measure to check how profitable an investment is in a year. Unlike absolute return, which considers the total return over the entire investment duration, annual return breaks down how well the investment performs by calculating an average yearly figure.

This approach gives a clearer view of how well an investment performs consistently year after year. To gain a deeper understanding of Annualised Returns, consider exploring our Reverse CAGR Calculator, which can help you compute these returns effectively.

To understand the annual return, picture an investment scenario where its value goes up and down over several years.

The annual return calculation evens out these fluctuations, providing a normal method to compare different investments or track the yearly performance of a single investment.

What is the Annualised Return Formula?

The Mathematical formula to calculate absolute returns is

Annualized Return = ((1 + r1) × (1 + r2) × (1 + r3) × … × (1 + rn))^(1/n) – 1

Where r is the Appropriate Return and n is the number of years.

Fund NameAMC3-Year Annualized Return (%, as of Jan 2024)5-Year Annualized Return (%, as of Jan 2024)
UTI Small Cap FundUTI MF32.54%26.47%
Axis Small Cap FundAxis MF27.81%24.23%
Canara Small Cap FundCanara Robeco MF24.89%21.45%
HDFC Small Cap FundHDFC MF27.29%23.78%

For further insights on evaluating investments, our article on the Advantages of Financial Planning offers valuable information.

Which is Better: Absolute Return vs Annual Return?

Determining whether absolute return or annual return is “better” mostly depends on the investment context and the investor’s specific goals and preferences. Both metrics provide unique insights and serve different purposes in the world of investment analysis.

When Absolute Return is Preferable:

  • Short-Term Investments: For investments held for a short period, absolute return is more relevant. It directly indicates the profit or loss over that specific timeframe.
  • Specific Project or Goal-Oriented Investments: If your investment has a fixed end date tied to a particular goal or project, absolute return offers a clear view of the contribution towards that goal.
  • Simplicity and Clarity: Absolute return is simple to calculate and easy to understand. It’s great for investors who appreciate simplicity in their investment analysis.

When Annual Return is More Suitable:

  • Long-Term Investments: If you’re holding onto investments for several years, annual return offers a more accurate idea of how the investment performs on average each year, considering compounding effects.
  • Comparing Different Investments: When you’re comparing the performance of various investments, especially those with different time frames, annual return becomes a standard measure for a fair evaluation.
  • Understanding Consistent Performance: Annual return is useful for evaluating how consistently an investment performs over time. This is particularly important for long-term financial planning.

Difference between Absolute Return and Annualised Return

AspectsAbsolute ReturnAnnualised Return
DefinitionAbsolute return represents the actual percentage change in an investment’s value during a particular time period, without including the impact of compounding.Annualised return represents the average rate of return per year during a particular time period, including the impact of compounding on the investment returns
PurposeIt measures the overall gain or loss of the investment.It measures performance over the year, factoring in compounding.
CalculationFormula:
((Present NAV – Initial NAV)/ Initial NAV) × 100

Absolute return is calculated as a straightforward percentage change.
Formula:
((Present NAV/ Initial NAV) ^ (1/no. of years)) – 1

Annualized return is computed as the average annual return over a specified period.
LimitationsIt’s not clear how well the investment is doing over time, especially for long-term investments.Requires a more complex calculation and may not accurately represent periods of high volatility.
ExampleWhen the investment grows from $1,000 to $1,200 over two years, the absolute return is 20%.If the same investment grows to $1,200 over two years, the annual return is approximately 9.54% per year.

Find out the difference between a Block deal and a Block deal.

Conclusion:

Absolute Return and Annual Return (CAGR) are necessary measures of how an investment performs. Absolute Return shows the exact financial result, while Annual Return (CAGR) offers a normal way to compare different investments, making it more valuable for assessing long-term performance.

To fully understand an investment’s performance, investors should look at both measures, considering factors like risk tolerance and investment goals before making well-informed decisions.

To explore more about long-term investment strategies, consider reading about Asset Allocation Fund Strategies.

FAQs

  • Can both absolute and annualised returns be negative?

    Yes, both absolute and annualized returns can be negative, indicating a loss in the value of the investment over a specific period. A negative absolute return signifies an overall loss, while a negative annualized return reflects a compounded average annual loss.

  • Is Annualised Return always a better measure than Absolute Return?

    No, Annualized Return is not always superior to Absolute Return; it depends on the context and the information needed. They offer different perspectives, with Annualized Return considering compounding effects over time, while Absolute Return provides a straightforward view of overall gain or loss.

  • For long-term investments, which return metric is more advisable?

    It is generally advisable to consider the Annualized Return metric for long-term investments. This measure accounts for the compounding effects over multiple years and provides a more detailed and accurate assessment of performance compared to Absolute Return.

  • How do you calculate an Annualised Return on an investment?

    Annualized return on an investment, is calculated by dividing the total return of the investment by the number of years it was held and then multiplying the result by 100 to express it as a percentage.

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