Absolute Return

Definition:

Absolute returns refer to the actual gains or losses generated by an investment over a specified period, regardless of the performance of a benchmark or index. It is a measure of an investment’s success in achieving positive returns, without comparing it to external factors or market averages. Absolute returns focus on the raw profitability of an investment, providing a clear picture of its performance.

Investors often gauge the success of their investments by comparing them to market benchmarks such as the S&P 500 or a relevant index. While relative performance is important, absolute returns offer a complementary perspective. Here’s a deeper dive into absolute returns

Key Features:

Independent Evaluation: Absolute returns are independent of market conditions. They assess an investment’s performance on its own merits, making them valuable for evaluating strategies like hedge funds and alternative investments.

Risk Management: By focusing on the actual returns achieved, investors can better assess the risk associated with an investment. High volatility and inconsistent returns can be indicators of higher risk.

Diverse Application: Absolute returns can be applied to various asset classes, including stocks, bonds, real estate, and more. Investors can use them to evaluate individual investments or a portfolio as a whole.

Calculating Absolute Returns

The calculation of absolute returns is straightforward. It involves subtracting the initial investment amount from the final investment value and then dividing it by the initial investment amount. The formula is as follows

The formula for calculating absolute returns is as follows:

Absolute return = ((Selling price – Purchase price) / Purchase price) * 100

For example, if an investor initially invests ₹10,000 and the investment grows to ₹12,000, the absolute return is

Absolute Returns= (( ₹12,000 − ₹10,000) /  ₹10,000) * 100 = 20%

This indicates a 20% Absolute Return on the investment.
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FAQ's

Why are absolute returns important?
Absolute returns provide a straightforward assessment of how an investment or portfolio is performing without relying on external benchmarks. They help investors understand the true profitability of their investments.
How do absolute returns differ from relative returns?
Relative returns compare an investment’s performance to a benchmark or index, while absolute returns assess performance on its own merits. Relative returns provide context, while absolute returns offer a standalone evaluation.
Can an investment have positive absolute returns but negative relative returns?
Yes, it is possible. An investment may generate positive absolute returns but underperform compared to a relevant benchmark, resulting in negative relative returns.
Are absolute returns suitable for all types of investments?
While absolute returns can be applied to various investments, they are particularly useful for assessing alternative investments, hedge funds, and strategies that aim for consistent positive returns, regardless of market conditions.

Conclusion

Absolute returns provide investors with a valuable tool for evaluating the success of their investments independently of market benchmarks. By focusing on the actual gains or losses generated, investors gain insights into an investment’s performance and risk. While relative returns have their place, absolute returns offer a clear and unfiltered perspective on investment success.

Investors should consider both relative and absolute returns when evaluating their portfolios to make informed decisions and manage their financial goals effectively.