What Is an Absolute Return?

An absolute return quantifies an investment's overall gain or loss, expressed as a percentage, irrespective of market conditions, facilitating performance comparisons.

Oct 21, 2024 at 07:30 am

What Is an Absolute Return?

An absolute return is a measure of investment performance that expresses the total gain or loss of an investment over a specific period of time, regardless of the overall market conditions. It is typically expressed as a percentage, and it represents the actual amount of money that an investor has made or lost on an investment.

How Absolute Returns Are Calculated

Absolute returns are calculated by taking the current value of an investment and subtracting its initial value, and then dividing the difference by the initial value. The result is expressed as a percentage.

For example, if an investor buys a stock for $100 and sells it a year later for $120, their absolute return would be:

Absolute Return = (Current Value - Initial Value) / Initial Value
= ($120 - $100) / $100
= 0.20 or 20%

Absolute Returns vs. Relative Returns

Absolute returns are different from relative returns, which measure an investment's performance relative to a benchmark or index. For example, an investment may have an absolute return of 5%, but if the market index it is benchmarked against rises by 10%, the investment's relative return would be -5%.

Advantages of Absolute Returns

• Simplicity: Absolute returns are easy to understand and calculate.
• Comparability: Absolute returns allow investors to compare the performance of different investments over time, even if they are invested in different asset classes.
• Risk management: Absolute returns can help investors identify investments that have the potential to generate positive returns regardless of market conditions.

Disadvantages of Absolute Returns

• Limited information: Absolute returns do not provide investors with any information about the risk or volatility of an investment.
• Deception: Some investments may generate high absolute returns in the short term, but they may also be very risky.
• Difficult to achieve: Consistently generating positive absolute returns can be challenging, especially in volatile markets.

Conclusion

Absolute returns are a useful measure of investment performance that can help investors make informed decisions about their investments. However, investors should be aware of the limitations of absolute returns and should consider them in conjunction with other measures of investment risk and return.