Return on Assets – 7 Calculation Formulas. For beginners!
We live in a dynamic world where everything is changing rapidly. This applies to both technology and everyday life. Worst of all, when it is negative changes. Especially when they concern us personally. For example, we can be laid off at work due to business automation, and now our knowledge is no longer relevant. Therefore, you need to prepare for negative events in a timely manner. The best way to do this is to ensure your financial security. To do this, you need to create profitable assets with stable and high returns. What is profitability? What formula to use to calculate profitability and assets for beginners?
Let’s deal with this further.
So, the creation of profitable assets is the main and most reliable way to ensure your financial security. And not only in the distant future in retirement, but also at the present time.
Fundamentals of Investment
Competent investments bring stable income to their owner every month or at other intervals. Just this income will help us in difficult periods of life.
When creating your investment portfolio, you need to take care of dividing it (diversifying) into at least two parts. One of which will be aimed at increasing our capital, and the other will ensure the protection and safety of our funds.
Namely, the second protective part of our portfolio provides our constant and stable additional income.
At some point, the investor is faced with the need to conduct analytical calculations of the performance of his investment portfolio. This action is necessary for an objective forecast of its future value.
Without such analytics, it is impossible to make an informed decision on the amount of the next deposit and its timely rebalancing. Analytics will also be required to build an effective strategy for replenishing your case.
Return on assets is important
Contributors may make a mistake in the calculation due to the use of an incorrect formula. An incorrect assessment in investment planning entails certain risks, and its use in practice is unacceptable. The price of an error in miscalculations will be the standard of living in old age or the education of children, there will be a drawdown in any of the goals.
The importance of calculations
To do this, it is necessary to use the right methods for evaluating investments. But how to determine the return on assets? Let’s take a look at them.
Assessment of the average return on assets
The main algorithm for determining the effectiveness is as follows:
Total profit/ deposits*100%
Profit means the balance of the sale amount and / or the purchase amount of valuable shares. If the investor maintains a table with all completed transactions and income received, then the calculation is made in the following order:
Profit margin = profit and/or loss per trade + dividends received – costs.
For example: a depositor purchased AvtoVAZ shares for 20’000.00 🪙. A year later, he sold them for 25’000.00 🪙.
The amount of net profit was 5’000.00 🪙.
Profit amount 25% – (5’000.00/20’000.00)*100%
There is one serious flaw in this formula, with the help of it only absolute profitability is calculated, regardless of the method of obtaining.
Annual Profit Calculation
More accurate results are obtained by assessing the annual profitability, it is also called the portfolio return.
Thanks to this analytics, the investor sees how much he will earn for each entered 🪙 / dollar or other currency for the same time period.
For the value of "the same period of time" take a year.
Profitability (% per annum) u003d (profit in% * 365 days) / investment period in days.
For example, a depositor purchased securities of Raiffeisenbank for 20’000.00 🪙 and Gazprom for 40’000.00 🪙. After 6 months, at the time of the rise in paper prices, he sold the shares of Raiffeisenbank for 26’000.00 🪙. Valuable Gazprom shares were sold for 55’000.00 🪙 12 months later.
As for the average profitability, this parameter as a percentage is:
- Raiffeisenbank – 6’000.00 rubles. or 30.0%;
- Gazprom – 15’000.00 rub. or 37.5%.
In order to objectively assess the effectiveness of these financial injections, the data are converted into annual percentages:
Raiffeisenbank profitability=30%*365 days/180 days=60%
Profitability of financial investments in Gazprom = 37.5% * 365 days / 365 days = 37.5%.
Raiffeisenbank securities turned out to be more profitable assets.
Calculation of profitability taking into account the movement of funds
How is the annual return on a portfolio calculated? For this purpose, the value of the contribution is fixed at the beginning of the reporting year and at its end.
Example. At the beginning of the reporting period, the investor owned funds in the amount of 150’000.00 rubles. Thanks to profitable contributions, the case at the end of the year was estimated at 200,000.00 rubles. Net profit in this case was 50’000.00 🪙 or 33% per annum.
There is one obvious disadvantage in this method of project profitability analytics, due to which there are distortions in the numbers. This method does not take into account all possible transactions of funds on the account, and these are:
- Input and output of currency;
- Getting income “from the outside", for example, dividends from securities.
From the above example. If a month before the official end of the reporting period, the investor entered 50’000.00 🪙, how will this affect the final result? It turns out, 50’000.00 🪙 income or 33% per annum. But, in this case, the final result is zero.
Second option. A month later, the depositor withdrew 50’000.00 🪙, as a result of which his assets for the whole year had an amount 33% less than the original one. As a result, he increased the volume of his case by 50’000.00 🪙.
How to calculate the average annual return?
If the term of deposits is several years, then the investor analyzes the average annual profitability of his investments. In the process of making such a deduction, he can analyze the most effective methods for achieving his own goals – investments in shares and other effective financial products.
The compound interest formula is designed to ensure that the amount of the bet remains the same. This parameter is constant in bank deposits, in other ways of investments this value varies over a period of time. How to calculate return on investment?
If at the end of each reporting period the income is withdrawn, then the calculations are quite simple: they add all the profits:
Profit = Yield #1+ Yield #2+ Yield #3
For example, if investments in a startup brought 8% at the beginning, 10% in the second year, then in this case, the profitability of the asset over a period of two years will be 18%. This formula works with constant profit withdrawals. There are times when the investor reinvests the profit received from the asset, then the formula described above changes – instead of addition, multiplication takes place.
Profit = ((profit #1+1) (profit #2+1)-1) 100%.
For example, a startup brought in 12% in the first year, 10% in the second, 18% in the third year. The entire profitability of the asset is re-introduced, and the total interest begins to work.
Profitability = ((12%+1) (10%+1) * (18%+1) – 1) 100% = 45%.
Based on the previous formula, 40% comes out by adding interest, an additional 5% is achieved through reinvestment of funds.
Due to the constant change in the profitability of many financial instruments, it is convenient to use an average. Due to the average profitability, it is possible to adjust the value changes to one numerical indicator, which is convenient to use for detailed calculation and analytics of other investment options
Calculation of the average profitability of deposits
There are two options for calculating the average profit:
- In the first method, the emphasis is on the formula of total interest, where the exact amount of initial injections and income are known, and the number of investment periods is also determined;
- The second method involves finding the average number of profitability for the same period. Calculation algorithm: Average return = ((number of investment periods (yield No. 1 + 1) (yield No. 2 + 1) * 1) 100%.
Calculation of the average value using the second method: a startup in the first reporting quarter had a yield of 8%, in the second – 15%, in the third – 5%, in the fourth – 7%. Calculate the average profitability for one reporting quarter.
Substituting values into the algorithm:
Average Return = (((8%+1) (15%+1) (5%+1) (7%+1)) (14 – 1) 100%= (1.18*1.15 1.5 1 .7) (14 – 1) 100%= 3.46035 -0.75= 0.49744 – 1 100% = 5%
At some points, the refinement of the average profitability comes down to determining the annual interest that the depositor encounters in the text of advertising booklets of bank deposits. Having found out exactly the value of the profitability of financial injections for a certain period, the annual profitability is calculated based on the following algorithm:
Profitability = (investment profit / investment amount 365 / number of deposit days) 100%.
For example, the initial amount of financial investments is $20’000.00, the profitability of assets for 150 days is $3’000.00. What is the annual rate of return?
To do this, the investor substitutes digital values into the formula:
Yield = ($3’000.00/$ 20’000.00 365/150 100%= 32.84% per annum.
Calculation of profit from the deposit, taking into account the input and output
This task is relevant for experienced investors who replenish their portfolios on a monthly basis. Constantly at the time of input and output, the denominator of the main formula for calculating performance changes – the amount of injections. To calculate the exact profitability of deposits, find out the weighted average size of deposits, accurately calculate the profit from deposits, taking into account input / output.
The analysis is carried out according to the following analogy:
- Profit – (final amount + volume of withdrawals) – (start-up capital – total amount of deposits);
- The exact figure for the weighted average investment is calculated by dividing the investment period into parts, divided by input and output transactions: the amount of injections = period No. 1 deposit amount + period No. 2 (investments + input – the amount of withdrawals No. 1 / length of the investment period.
An example of this algorithm in practice: the investor replenished the project with $1000, after 4 months he contributed another $300. After 5 months, he withdrew $150. At the end of the year, his investment portfolio reached $1800. What is the profitability of the invested project:
- Stage 1 – calculation of the received investment profit: profit = ($1’800 +$150) – ($1’000+$300) = $650;
- Stage 2 — weighted average investment return: deposit amount =(4 1’000$+6*(1’000$+300$)+2 (1’000$+300$-150$))/12=(4′ 000$+7’800$+2’300$)/12 = 1’175$;
- Stage 3 – calculation of profitability: profitability = (650 $ / 1’175 $) * 100% = 55.3%.
This calculation algorithm is also used to assess the profitability of an investment portfolio. The formula was first developed and introduced by the American economist William Sharp. The algorithm remains relevant due to the ability to assess and calculate the likely risks and performance. The algorithm looks like this:
KSh u003d (YES – BD) / CO
- YES – return on assets for the specified period
- DB – return with zero risk
- SD – standard deviation.
Depending on the final value, economists clarify the potential profitability of a project. The resulting value has 3 possible outcomes:
- KSh >= 1 is the most indicative result, the contribution to this project will bring a certain profit;
- KSh = 0 or 1 – this indicates a high degree of risk, due to the detailed strategy being worked out. Apply these types of investments only after careful study;
- KSh < 0 – the strategy has low efficiency, its use as part of the portfolio will cause damage.
The main rule of the Sharpe ratio is that it is possible to significantly reduce risks when choosing a strategy with the highest ratio. Investors are always guided by this rule when choosing a particular strategy.
Disadvantages of the method:
- It is not always clear which values to consider. This algorithm is suitable for making approximate calculations, I will point out that when setting different values, the result differs significantly;
- Due to the inaccuracy of comparisons, several values have to be applied. The greatest effect will bring the miscalculation of several values for the same period of time;
- There is no need to compare high and low risk deposits, as the result is very clear here.
All these nuances are taken into account when using this calculation algorithm.
Average annual profitability and CAGR algorithm
The average annual value is calculated quite simply – add up all the profitability for the period and divide them by the number of years. If there are few such indicators, then the result of such calculations is close to the true ones.
If the necessary data on profitability are not available, but the amounts of starting and ending capital are exactly known, then the CAGR formula is great in this situation:
(Portfolio price at the end of the period / Portfolio price at the beginning) 1 / number of years – 1
This formula is suitable in the case when the deposit was entered once at the start, after which the depositor did not make any transactions on the account.
Method of valuation of contributions IRR or internal rate of return (IRR)
This is the easiest way to evaluate the performance of contributions and investments. IRR is an interest rate where the written value of financial injections is equal to the value of the original investment. With the help of this economic value, the prospects of the project are assessed.
GNI is easily calculated in EXCEL tables. Using this template, the profitability is calculated for each of the investment periods separately or for the 6th period at once. In the date column indicate any desired date. The only point is that the investor needs to enter data for each replenishment and withdrawal of funds. The analysis uses the algorithm – XIRR (CHISTVNDOH).
In addition to the GNI of the portfolio, using this tool, investors look at the total increase in investments, how much its size differs from the amount of invested finance.
The main quality of such a calculator in the EXСEL program is the determination of the prospects of investments for diversified deposits.
Wealth of choice
Important nuances of investing
A common misconception of newcomers to investing is associated with small numbers in determining performance. Novice investors believe that an error of 1-2% does not mean anything, they consider it a penny. Multiplying 10000 🪙 by 1% gives you 1000 🪙, this number seems so insignificant. Profitability is determined within one year, but if you look at the amount of 1000 🪙 within several investment periods. Therefore, it is important to take into account all points when carrying out analytical calculations so that the result is obtained with the greatest accuracy.
The described algorithms help to objectively assess the profitability of investments, the main indicator is accuracy. Such an algorithm takes into account all the nuances associated with the input and output of funds received, and receives a correct calculation of profitability.
When an investor uses trust management services, he is provided with reporting on the algorithm for reporting, he will be able to assess the correctness of using the algorithm when assessing the profitability of his investments.
If the investor is serious about calculating the profitability of the project, since this parameter is important when analyzing the effectiveness of the contribution. If the calculations are made incorrectly, then it will create an incorrect idea of the effectiveness of the chosen strategy for your investments. Therefore, for an objective analysis and the correct selection of an investment strategy, economists choose the most accurate algorithms, while knowing the exact investment period.
Now you know that profitability is an important indicator for an investor. And you understand how to calculate it as a percentage or per annum. As well as evaluate profitability and assets.