Return is a financial result of investments, which shows how much an investor has earned (or lost) on their assets. Return consists of two parts:
Income from assets. This is the part of the profit that an investor receives in addition to changes in the value of assets. For example, dividend payments, when the issuing company shares part of the profit with shareholders, coupon income, rent for real estate, and so on.
Return is directly related to risk in direct proportion. The higher the expected return, the higher the risk of not getting it at all. And the main task of an investor is to find the most optimal ratio of risk and return in order to get maximum profit.
The goal of any investment is not only to preserve but also to increase capital. Therefore, the return on assets indicator directly affects investment activity. It is important to know the return on investment for the following tasks:
Asset selection. A quantitative indicator of return will allow you to compare the profitability of various assets most accurately and select the most effective ones for the investor's portfolio.
Determining a strategy. Return on investment in relation to risks will help you decide on a strategy and adjust the current one in accordance with your investment expectations.
Forecasting results. Assessing the return on various assets for previous years will help you predict further developments and decide whether to purchase, for example, certain securities or not.
Formation of a portfolio. To diversify risks, it is important to invest in instruments with different levels of risk and return, and assessing these indicators will allow you to assemble the most suitable investor portfolio in accordance with the chosen strategy.
Investing is directly related to profitability, so it is extremely important to correctly calculate this indicator and take it into account in your investment activities.
The return on investment is calculated based on data from previous years. For example, if an asset shows approximately the same return for 3 years in a row, then the return will probably remain at the same level next year.
However, this method has significant drawbacks, because such an analysis does not take into account the following factors:
The reliability of the company. If the issuer declares bankruptcy and is unable to redeem bonds or pay dividends, the asset will be unprofitable even with positive statistics in the past.
Political and economic events. Various external factors directly affect the value of assets, and it is almost impossible to predict them. At any moment, something can happen that can either cause the value of assets to fall or, conversely, increase in price.
Increasing the return on investment will help to quickly build up capital and achieve the set goal. There are several ways in which an investor can increase the profitability of his portfolio:
Reinvestment of dividends, coupons and interest payments. In this case, the income received is used to purchase additional company assets. This increases capitalization and subsequent income from both stock growth and dividend payments. Moreover, this allows the company to grow faster, show positive dynamics and increase dividends.
Invest in different companies. Depending on the chosen strategy, the portfolio should include issuers from different sectors of the economy, companies with small and medium capitalization, and also combine the cost approach and investing in growing companies. Over a long investment horizon, such a strategy, as a rule, shows greater growth due to competent portfolio optimization.
Use alternative investments. This can be the venture market, crowdlending, raw materials instruments, etc. Even 20% of such assets in a classic portfolio significantly improves the ratio of profitability and risks.
Return on investment is an important indicator of investment efficiency. It is necessary for analyzing the current situation, selecting assets, adjusting the strategy and creating an investor portfolio.
Special formulas are provided to calculate the return. They can be used to estimate the nominal, real, full, annual return and other indicators for assessing the situation from different angles.
However, the return does not reflect such indicators as the reliability of the issuer or external factors, such as political or economic events. Therefore, it is important to monitor the situation on the market and, if possible, use methods to increase the return on investment.
