What it means
A portfolio might hold shares, bonds, property and cash. Each earns a different return, so the portfolio's return is a weighted average, meaning each return is counted in proportion to the share of money invested in that holding.
A large holding has a larger effect than a small one. The measure includes both income, such as interest and dividends, and changes in market value.
The return is usually shown as a percentage of the starting value. It can be calculated for any period, such as a month, a quarter or a year, and for a single period it is simple arithmetic.
Over several periods, returns compound, which means each period's return is applied to a balance that already includes earlier gains or losses. To combine periods, you multiply the growth factors rather than adding the percentages.
A gain of 10% followed by a loss of 5% is not a 5% gain. Money flows complicate the picture.
If the investor adds or withdraws cash during the period, the simple formula can mislead. Professionals use time-weighted returns to judge the manager's decisions without the effect of cash flows, and money-weighted returns to show what the investor actually experienced.
Portfolio return should always be read together with risk. A 12% return achieved with wild swings is not the same as 12% from a steady portfolio, so analysts also look at measures such as standard deviation and the Sharpe ratio.
Comparing the return with a suitable benchmark shows whether the strategy added value. Fees and taxes reduce the return investors actually keep, and they are easy to overlook when comparing funds.
Always check whether a quoted figure is before or after costs, because a small difference in fees compounds over many years.
In practice
Real-world examples.
Example
A retiree reviews her annual statement from her broker. Her shares gained 12% and her bonds gained 3%, and with an even split between them, her portfolio return is 7.5%. In dollars, on a $200,000 portfolio, that is a gain of $15,000.
Example
A company pension fund compares its portfolio return of 6.8% with its benchmark of 6.2%. The trustees conclude the managers added value after fees. The excess of 0.6 percentage points is modest but consistent.
Example
A small business with $150,000 of spare cash invests it in a mix of deposits and bonds. The finance manager calculates the weighted return each quarter to report to the owners. The simple table shows each holding, its weight and its contribution.
Formula
Calculation
Portfolio return = sum of (weight of each holding x return of each holding)
Suppose a $1,000,000 portfolio has $400,000 in shares that returned 10% and $600,000 in bonds that returned 5%.
Weight of shares = 400,000 / 1,000,000 = 40%, and weight of bonds = 60%.
Portfolio return = 0.40 x 10% + 0.60 x 5% = 4% + 3% = 7%.
In dollars, the gain is 400,000 x 0.10 + 600,000 x 0.05 = 40,000 + 30,000 = $70,000, which is 70,000 / 1,000,000 = 7%.
Over two years, with returns of 10% and -5%, the combined return is 1.10 x 0.95 - 1 = 1.045 - 1 = 4.5%.Case study
Seen in the real world.
Linden Park Foundation is a fictional charity with a $2,000,000 portfolio. In this illustrative review, it holds $1,200,000 in global shares, which returned 8%, and $800,000 in bonds, which returned 3%. The finance officer calculates the portfolio return as (1,200,000 x 0.08 + 800,000 x 0.03) / 2,000,000 = (96,000 + 24,000) / 2,000,000 = 6%.
The trustees had hoped for 7%, but the officer shows that the benchmark for this mix returned 5.0%, so the portfolio did better than its reference. She also reports a 0.5% annual fee, bringing the net return to 6% - 0.5% = 5.5%, which is still above the benchmark.
The trustees accept the result and are reassured that the portfolio return exceeded the benchmark and decide to review whether the shares and bonds split matches the charity's spending needs. They record the analysis in their annual report.
Watch out
Common mistakes.
- Averaging percentages without weighting them. A small holding should not count as much as a large one.
- Adding returns across years. Compounding means the periods must be multiplied, not added, and a 50% loss needs a 100% gain to recover.
- Ignoring fees and taxes. The return you keep is lower than the gross figure.
Questions
People also ask.
What is the difference between time-weighted and money-weighted return?
Time-weighted removes the effect of cash flows to judge the manager, while money-weighted reflects the investor's actual timing of deposits and withdrawals.
Can a portfolio return be negative?
Yes. If losses outweigh gains and income, the return is negative, and the loss is measured against the starting value, so a fall from $100,000 to $92,000 is a return of -8%.
What is a good return?
It depends on the risk taken and the benchmark. A return should be compared with a relevant benchmark and judged alongside risk, and it should be measured over a long enough period to be meaningful.
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