How to Calculate Your Portfolio’s Investment Returns

You don’t need a doctoral degree in finance to calculate your portfolio’s investment returns. A few principles are enough to make even the most math-phobic savvier investors. Knowing your potential returns is not simply wise; it is essential.

Your investment returns can be calculated by comparing their current and initial values while accounting for dividends or interest earned. Although you can’t predict exactly how your investment portfolio will perform, you will better understand each asset’s expected gains while gauging consequential factors such as downside risk, market conditions, and the time each investment will take to realize its returns.

We look at the different methods for calculating your returns, the effect dividends and interest have on your overall portfolio, and the importance of considering downside risks and opportunity costs, which refer to how much you would have gained from alternative investment vehicles over your current portfolio.

Calculating Returns for a Single Investment

Focusing first on individual assets is an indispensable and great way to start understanding your portfolio’s overall performance. One basic measure comes from calculating each asset’s return on investment (ROI), which establishes how effectively an asset is putting your money to work.

Example: You invested $1,000 in a dividend-paying stock and sold it a year later for $1,500. Over the year, you also earned $20 in dividends and paid $5 in trading commissions.

1. Find your initial cost by adding how much you spent to buy the investment, including commissions. Here, it’s $1,000 + $5 = $1,005.
2. Check the asset’s current value by looking at its worth today. A quick internet search or checking your investment account is all you need to do. In our example, it’s $1,500.
3. Add in any dividends and other payouts you’ve received for this asset: $1,500 + $20 = $1,520.
4. Subtract the cost from the current value plus dividends, which in our example is $515.
5. This gives you the net gain—basically, how much you’ve earned or lost.
6. You’re ready to calculate the ROI: Divide the net gain by your initial cost. If you want your number as a percentage, multiply it by 100: 515/1000 = 0.515 or 51.5%.

Calculating Returns for an Entire Portfolio

Navigating the financial landscape requires a keen understanding of your investments’ performance. This becomes all the more complex when you’ve diversified your portfolio across various assets, from stocks and bonds to real estate and alternative investments. Each asset class has its own variables—dividends, interest rates, management fees, and tax considerations—affecting your overall ROI. Working out the returns on individual investments is not hard, but calculating an entire portfolio without a spreadsheet app could prove a bit laborious, especially if your money is spread across different investment vehicles with multiple firms and institutions.

The first step to calculating the returns on your portfolio is to list each type of asset in a spreadsheet. Next to each asset, include the calculated ROI, dividends, cash flows, management fees, and any other figures relevant to the cost or returns of those assets. To perform these calculations, you’ll need to know:

• The total cost of each investment, including any fees and commissions
• The historical returns of each investment, including dividends and cash flow
• The portfolio weight of each investment, represented as a percentage of the portfolio’s total value

The last two sets of figures can be used to estimate portfolio returns: Multiply the ROI of each asset by its portfolio weight. Then, sum these together, and this gives you the total portfolio return, providing a clear picture of how your portfolio is doing.

Time-Weighted Returns

When evaluating the performance of your portfolio, the time-weighted return (TWR) helps you focus on the portfolio’s investment performance. Unlike money-weighted returns, which consider the amount and timing of individual cash flows (like deposits and withdrawals), TWR removes the impact of external cash flows, providing a more accurate measure of the effectiveness of your investment manager, which might be you.

TWR is especially helpful for evaluating your investment strategy if you regularly contribute to or withdraw from your portfolio. Doing so can distort your picture of how well the investments are performing independently of your deposits and withdrawals. Time-weighting dissolves these effects, allowing you to assess the portfolio on its merits. The main advantage of TWR is that it will enable you to fairly compare different portfolios or funds, as it’s not affected by contributions or withdrawals. This makes TWR useful for comparing fund managers.

Imagine breaking your investment journey into book chapters. A new chapter begins each time you add or take out money from your portfolio. In each of these chapters, your investments will experience gains or losses. The key is to look at how well your investments perform in each chapter, independently of any money you added or withdrew.

To calculate the TWR, you find the rate of return from each chapter and add one to it. Once you have gotten the rate of return for each chapter, multiply them together. Finally, subtract one from that total. By doing so, you are essentially weaving together the separate tales of each chapter into a single, unified story of your portfolio’s performance.

For example: Let’s take the $1,000 we’ve been investing and put it in a mutual fund on January, 1. In the exact middle of the year, your investment is worth $1,200, and you deposit an additional $500, bringing your total to $1,700. At the end of the year, you look at your statement and see it’s worth $1,600.

For the first half of the year, your rate of return is 1,200 − 1,000 / 1,000 = 0.20 or 20%.

The year’s second half is a little more complicated, but not by much. Your starting point for the second half is $1,700 (the $1,200 amount at that point plus the $500 deposit). Your endpoint at the close of the year is $1,600. To find the rate of return for the second half, you’d calculate 1,600 − 1,700 / 1,700 = −0.059 or -5.9%.

To find the TWR for the entire year:

1. Add 1 to each sub-period return: 1 + 0.20 = 1.20 for the first half and 1 − 0.059 = 0.94 for the second half.
2. Multiply these together: 1.20 × 0.94 = 1.13. Subtract 1, and your TWR is 0.13 or about 13%.

TWR’s advantages include providing a more precise look at the portfolio’s performance by eliminating the impact of external cash flows like deposits and withdrawals. This makes the tool valuable for assessing the skill of portfolio managers and comparing them to others based on what they can control: their investment decisions.

There are disadvantages since calculating TWR can be complex and time-consuming, especially for portfolios with frequent cash flows. It often requires specialized software and meticulous bookkeeping. TWR also cannot assess the impact of individual investment timing. For an individual investor who wants to know the return based on their specific deposit and withdrawal timings, the money-weighted return (MWR) is more appropriate.

Money-Weighted Returns

Money-weighted returns, unlike TWR, account for the timing and size of an investor’s contributions and withdrawals. This is based on the internal rate of return for the portfolio, meaning it makes the present value of all cash flows and the ending portfolio value equal to the initial investment. MWR, thus, reflects the personal return experienced by a portfolio’s investor.

The main advantage of MWR is as a personalized view of investment performance. It captures investors’ financial journey, representing their individual choices’ impact on investment outcomes. This approach allows for a more nuanced understanding of real returns, especially when an investor has made multiple contributions or withdrawals.

Nonetheless, MWR has disadvantages. First, MWR is not well suited to comparing the performance of different fund managers or investment strategies. This is because it doesn’t isolate the returns on the investments from the investor decisions of when and how much to contribute or withdraw from a portfolio. Additionally, the calculation of MWR can become complicated, particularly when multiple, irregular cash flows are involved. Lastly, the MWR method is highly sensitive to the timing of these cash flows. An investor who contributes more just before a market upswing may see an inflated return, whereas withdrawal at a market low could result in a deflated MWR.

More Factors to Consider

We’re making good progress, having one way to compare our returns to others and another for gauging our financial decisions. However, TWR and MWR don’t capture significant elements of your returns, such as the holding period for each asset or additional returns from bond payments or stock dividends.

For instance, TWR and MWR don’t offer much detail regarding specific holding periods for different assets. If you’re looking for a more comprehensive portrait of your portfolio, you’ll need to venture beyond these metrics. One starting point is to define the period for evaluating returns. Whether you’re assessing performance on a daily, weekly, monthly, quarterly, or annual basis can substantially influence how other income factors like dividends and interest are incorporated.

Additionally, calculating the net asset value (NAV) for each position during the chosen time frame is vital. NAV provides an asset’s worth, accounting for fluctuations in the market and other variables. Another consideration is the erosion of returns by taxes and fees. While TWR and MWR offer a view of your pretax returns, you’ll want to calculate the after-tax impact for a sense of what you’re actually gaining. And lastly, it’s important to remember that a portfolio typically includes a mix of diverse asset classes, each carrying its own risk and return profile. Understanding how each asset class contributes to the overall portfolio will give a more granular view of your investment performance.

MWR and TWR are limited in helping you with downside risk, which is the potential for an asset or portfolio to decrease in value. While it’s far nicer to focus on potential gains, understanding downside risks is crucial for managing risk. Market volatility, economic downturns, or poor corporate performance can increase downside risks. There are investment strategies that can help counter downside risks, including diversification and risk-mitigation financial instruments like options. Downside risks are critical when considering your risk tolerance and investment time horizon. Overlooking them can lead to an overexposure to volatile assets, resulting in significant financial losses.

Another factor to consider when reviewing your portfolio results is opportunity cost, an economic concept highly relevant in financial markets. Opportunity cost is what you give up in potential returns by investing in one asset instead of another. For example, suppose you keep your money in a savings account with a low interest rate instead of investing in the stock market. In that case, the opportunity cost is the potentially higher return you would have earned. Understanding opportunity costs can help guide investment strategy, reminding you to consider the benefits of one investment and what you may be losing by not investing in another. It’s a critical lens for evaluating potential trades, asset allocation, and even decisions around holding cash.

By considering these additional factors, you’ll be better positioned to develop a comprehensive understanding of your portfolio’s performance beyond what TWR and MWR alone can provide.

Holding Period Return

As you get a better handle on the different metrics for your portfolio, you’ll eventually cross paths with holding period return (HPR). Once you’ve established the time frames for your analysis and accounted for the NAV of each asset, you’re set to dive into calculating the HPR.

Here’s the formula for HPR:

HPR = Income + (End of Period Value — Initial Value) ÷ Initial Value

This metric has a compelling advantage: it doesn’t just focus on capital gains or losses; it also includes income from other sources like dividends or interest payments. It’s a snapshot of your returns from holding a portfolio—or even just a single asset—over a period. This makes it handy for comparing investments that have different holding periods. For example, if you held one set of stocks for a year and another for just six months, the HPR can normalize these different timelines, allowing for an apples-to-apples comparison.

HPR is particularly handy for investors with a mix of income-generating assets, such as bonds and dividend-paying stocks.

Adjusting for Cash Flows

Your portfolio is never at rest. You’ll add or remove funds through deposits, withdrawals, or reinvesting your dividends. While these changes will reflect your investment strategy and financial needs, they also introduce complexities when calculating returns, making it challenging to distinguish between changes in portfolio value that result from investment performance and those that arise due to added or withdrawn funds.

For instance, you deposit an extra $100 into your portfolio mid-month. That added sum will inflate your end-of-month NAV, though it’s not the result of a nifty investment idea—it’s simply the new capital. This is where adjustments for cash flows come in, ensuring that these financial movements don’t skew your calculated returns.

There are multiple methods to account for this complexity, but among the most popular is the modified Dietz method. This formula adjusts for the timing and size of cash flows, providing a more precise gauge of portfolio performance. In a nutshell, the modified Dietz method weights each cash flow by the time it has been in or out of the portfolio.

Another method for adjusting returns for cash flows is the internal rate of return (IRR), a discount rate that makes the net present value of all cash flows zero. Using a financial calculator or spreadsheet software, you can quickly compute the IRR, which gives you an effective means for normalizing returns and accounting for deposits, withdrawals, etc., and providing a measure of the potential profitability of an investment.

By making these adjustments for cash flows, you elevate the precision of your return calculations and are closer to an accurate representation of your portfolio’s performance.

Annualizing Returns

While navigating your investment returns, you’ll often see figures reported on different timelines—monthly, quarterly, or biannually. These different reporting periods could cloud your view when making fair comparisons between your portfolio and others, or between different asset classes. This is where annualized returns come in. Essentially, annualizing returns provides a common denominator for comparing returns.

Annualizing returns converts your multi-period returns into a standardized yearly figure. But it doesn’t just prorate your returns over 12 months. Instead, you’re calculating what your return would be if the investment continued to perform the same over an entire year, accounting for the effect of compounding.

The annualized return does not indicate the volatility experienced during the period you’re looking at. That volatility is better measured using standard deviation, which shows how data is dispersed relative to its mean. Annualized returns are not predictive either, but they give you a clean, comparable rate of return that makes it easier to compare investments across the board, regardless of their original timelines.

Example of Calculating Portfolio Returns

Let’s put this all together in an example. Suppose the total investment positions in a brokerage account were $10,000 at the start of the year and $13,350 at year-end. You also received a dividend June 30 for $500 and had to pay $150 in fees and commissions.

ROI = (Net gain on investment + dividends — fees) / Initial cost of investment

The first step is to take the total gain for the year and subtract the initial investment cost. Then, we add in the dividend and subtract out the fees and commissions:

• ROI net gain = $13,350 — $10,000 + $500 — $150 = $3,700

The next step is to take the net gain and divide it by the initial investment amount:

• ROI = $3,700 / $10,000 = 0.37 or a 37% gain

This is a straightforward way of calculating a portfolio’s return. However, the scenario gets more complex if additional deposits or withdrawals are made during the year. For instance, if you made a $5,000 deposit, the year-end balance would go up to $18,350. Ignoring this deposit would skew the ROI, making it seem the account earned $8,350 in market gains and dividends—not including any fees or commissions. The correct approach is subtracting the $5,000 deposit, leaving only the original $13,350 year-end balance for a better ROI calculation.

There are additional methods for calculating the rate of return, such as adopting a quarterly or monthly basis that accounts for dividends and compounding. The timing of cash flows, the diversity of assets, changes in market valuations, the sum of reinvested dividends, and commissions and fees can change your view of your portfolio’s results. A better understanding of these different metrics is crucial for assessing the effectiveness of your strategy to meet your financial goals.

The Bottom Line

Calculating your portfolio’s returns is vital to understanding which assets are succeeding for you—and those that aren’t. Investors should consistently assess their portfolios to determine how to improve their performance. While today, most brokers calculate portfolio returns and other statistics for you in your online portfolio, it’s still essential to understand what methods for calculating returns will give you the best assessment for your needs.