Rate of Return

Expressing returns as a percentage makes investments of different sizes comparable. A profit of 500 sounds better than a profit of 300, but not if the first required an investment of 10,000 and the second only 2,000. The first is a 5% return; the second is 15%.

To calculate a simple rate of return, take the ending value, add any income received, subtract the starting value, and divide by the starting value. If you invest 4,000, receive 100 in income and the investment ends at 4,300, your rate of return is 400 divided by 4,000, or 10%.

When an investment is held for several years, returns are usually converted into an annual rate so they can be compared. If 10,000 grows to 12,100 over two years, the total return is 21%, but the annual rate of return is 10%, because 10% growth in the first year and another 10% in the second produces 21% in total.

Rates of return can be quoted before or after fees, taxes and inflation. The real rate of return, after inflation, shows how much purchasing power has actually grown.