How To Calculate Absolute Return In Low-Risk Assets?

How to Calculate Absolute Return in Low-Risk Assets1. Definition

Absolute return is a performance measure that reflects the actual return an investor has earned over a specific period, regardless of the market's performance. Low-risk assets are typically considered to be those that have a lower volatility than the overall market, such as bonds or money market accounts.

2. Formula

The formula for calculating absolute return is:

Absolute Return = Ending Value / Beginning Value - 1

3. Example

Let's assume you invest $1,000 in a bond that matures in one year and pays an annual interest rate of 5%. At the end of the year, the bond is worth $1,050.

Absolute Return = $1,050 / $1,000 - 1 = 0.05

This means that you have earned an absolute return of 5% over the one-year period.

4. Considerations

When calculating absolute return for low-risk assets, it is important to consider the following:

• The holding period: Absolute return is typically calculated over a specific holding period, such as one year or five years.
• Inflation: Absolute return should be adjusted for inflation to provide a more accurate measure of performance.
• Fees: Any fees or expenses associated with the investment should be taken into account.

5. Advantages

Absolute return can be a useful performance measure for low-risk assets because it:

• Provides a clear and concise way to track performance over time.
• Allows comparison of different low-risk investment options.
• Facilitates risk-adjusted decision-making.

6. Limitations

Absolute return does have some limitations, including:

• It does not consider the relative performance of the investment compared to other asset classes or benchmarks.
• It can be misleading if the holding period is too short.
• It does not account for the investor's risk tolerance.

Conclusion

Absolute return is a valuable performance measure for low-risk assets. By understanding how to calculate it and its advantages and limitations, investors can make more informed investment decisions.