Saturday, March 24, 2007

Computing Your Annual Rate of Return

Once you have your total return index computed it's real easy to compute your annual rate of return for any period you choose. Here is my total return index for the last couple of years:

To compute the annual return for 2006 we just divide the index for December 2006 by the index for December 2005:

1951.8/1642.52 = 1.1883

and subtract one:

1.1883-1 = 0.1883

In percentage notation that's 18.83%.

Of course we can work out the rate of return for any period of more or less than 12 months. From the end of January 2005 to the current date in March 2007 we get: 2088.22/1652.11-1 = 26.40%. We can also work out what that is at annual rate. Here we'll need a program like Excel:

AnnualizedROR = (2088.22/1652.11)^(12/26)-1 = 11.42%

The hat sign is how Excel represents "to the power of". 26 is the number of months from the end of January 2005 till now and 12 is the number of months in a year. We can do the same thing for periods of less than a year... for example my annualized rate of return so far this year is:

AnnualizedROR = (2088.22/1951.8)^(12/3)-1 = 31.03%

If you wanted to compute the average return per month for a given period, you'd just replace 12 with 1 in the formula. Next, I think I'll cover comparing your performance to benchmarks. I'm happy to take suggestions for topics on this theme to cover.

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