Rate of return

What is the rate of return?

Rate of return (ROR) is the loss or gain of an investment over a certain period, expressed as a percentage of the initial cost of the investment. Essentially, it measures the profitability of an investment. A positive ROR indicates that the investment has generated a profit, while a negative ROR signifies a loss. No matter what type of investment you make, you will always have a rate of return associated with it.

How to calculate the rate of return?

Calculating the rate of return for an investment involves a straightforward formula. First, you subtract the starting value of the investment from its final value. Be sure to include any dividends or interest earned during the period. Then, you divide this amount by the initial value of the investment. Finally, multiply the resulting figure by 100 to express the rate of return as a percentage.

For instance, if you invested $1,000 and the value grew to $1,200, including dividends, the calculation would be as follows:

Final value: $1,200
Initial value: $1,000
Rate of Return = (($1,200 – $1,000) / $1,000) * 100 = 20%

In this example, the rate of return on your investment would be 20%.

Why is the rate of return important in trading and investing?

The rate of return provides traders and investors with crucial information for making future trades or investments. It helps in evaluating the performance of an investment and determining whether the cost is justified by the potential profit or loss. While traders might use it for short-term trades, it is more commonly used by long-term investors to assess the viability of their investments over extended periods.

What is the difference between rates of return for shares and bonds?

The method of calculating the rate of return differs for shares and bonds due to the different ways they yield earnings. Shares typically yield dividends, whereas bonds carry interest.

For shares, the rate of return calculation includes the dividends received and the change in the share price. For bonds, it includes the interest earned and any appreciation in the bond’s value.

What is an example rate of return calculation for shares?

Consider you own two shares of ABC Limited, which you purchased at $40 each, making your initial investment $80. Over one year, ABC Limited pays out dividends of $2 per share, totaling $4. The share price also increases to $50. Your total investment value now is $104 (the new share value plus dividends).

The calculation would be:

Final value: $104
Initial value: $80
Rate of Return = (($104 – $80) / $80) * 100 = 30%

Thus, the annual rate of return for your shares is 30%.

What is an example rate of return calculation for bonds?

Suppose you own a $100,000 bond with a 5% annual interest rate, which matures in four years. Each year, you earn $5,000 in interest. If you sell the bond for $120,000 after one year, the appreciation is $20,000.