Explained: What is absolute returns and how it is calculated

For any investor, the main objective is to generate a good return and create wealth. However, a significant challenge that remains here is to value the investment to determine its profit potential accurately. That said, mutual fund investments are one such investment that requires a thorough understanding of how the earnings are computed, especially when it comes to the absolute returns and compounded annual growth rate (CAGR). Let’s take a look at how they differ and what investors should understand about it.

What are absolute returns?

Absolute Returns are simply the amount of profit or loss made on an investment. It is the most straightforward method of computing returns. The absolute returns are also denoted by the term ‘Year-on-Year Returns’. It displays the fund’s exact return over the last year.  While selecting an equity fund, instead of focusing on the fund’s absolute or one-year return, it is always advisable to consider its compound annual growth rate (CAGR). CAGR is a percentage-based measure used to determine the annual rate of return on investment over more than one year. In other words, CAGR informs you of the average rate of return on your investment over a specified period.

How are absolute returns calculated?

To calculate, let us take an example to understand it better. Mr. Jethalal Ghada’s investment was Rs 1,43,600 at the end of 2019, and his investment matures at Rs. 1,51,000 after a year. His absolute returns will be the following:

Returns on Investment = (Final Value – Initial Value) / Initial Value * 100

= (Rs 1,51,000- Rs 1,43,600/ Rs 1,43,600) *100 = 5%

What is the drawback of absolute returns?

Returns for funds that are less than a year old are calculated using the absolute return method. In all other circumstances, annualised return, i.e., CAGR, is considered widely as represents an investment’s average annual return over a specified time period.

What should investors know?

-Absolute returns analyse only the price movement between two points. We can utilise absolute returns to calculate three-month, six-month, one-year, three-year, and five-year returns. It is recommended to use the CAGR for tenures greater than one year to obtain a more accurate picture.
-It gives a better picture of a short-term investment horizon for faster returns.
-The volatility does not impact absolute returns.
-It is one of the simplest methods to calculate the returns.