In this post, we will review the basic terms everyone should know when it comes to calculating investment returns: market value, gain/loss and flows. No worries if you don’t know what a gain/loss is or what flows mean, I will explain this and much more in detail below.
First, What is an Investment Return?
An investment return expresses how much you gained or lost on your investments in percentage terms.
There are actually two popular ways of calculating investment returns: one is called a “time-weighted return” which is what we discuss below, and another way is an “internal rate of return” which we discuss in another post. We have also done a comparison of the two if you are interested.
What Data Do You Need to Calculate A Time-Weighted Investment Return?
You need four key elements to calculate an investment return:
* 2 Market values
– Beginning market value
– Ending market value
Now let’s jump into what each of these key elements mean with a practical example.
John invests $100. Over the next year, his investment grows by $10 and he does not contribute or take out any money from his account. His ending value is $110.
What is his beginning market value, ending market value, gain/loss, and flows?
1) Beginning Market Value: Beginning Market Value is a fancy term used to describe the amount of money you start with when investing.
In this example, John started his investment with $100 so his “beginning market value” is $100.
2) Gain/Loss: Gain/loss is the amount of money you make or lose on your investments. A gain means you earn money from your investment and a loss means you lost money on your investment.
By the way, Profit and Loss (P&L) is another term for gain/loss.
In this example, John made $10 on the $100 he invested. That means his “gain” or “profit” was $10. On the other hand, if John lost $20 his “loss” would be $20.
3) Flows: Flows are any additional money you add to your investment account, or any money you withdraw from your investment account.
In this example, John did not contribute or withdraw any money from his account, so his “flows” are $0.
4) Ending Market Value: Ending market value is the amount of money you end up with. This means that if you’re reviewing your monthly, quarterly or annual statement, the ending market value is the balance after any gains, losses and flows.
You can actually derive the Ending Market Value from the first 3 key elements using this formula:.
Ending Market Value = Beginning Market Value + Gain/Loss + Flows
In this example, since John started with $100, gained $10, and did not add or take away money, then his ending market value is $110.
However let’s say John took out $5, what would his ending value be then?
If John started with $100, gained $10, and took out $5, his ending market value would be $105.
Lastly, here is a 5 minute video which explains these concepts.
Now that you’ve mastered these concepts, you’re ready to move on to calculate your return on investments.