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Introduction to Return 📈

In the realm of investments, "Return" is the primary motivation for any investor to part with their current money. It is the reward for waiting and for taking risks. For a student of Portfolio Management, understanding return is the first step toward building and evaluating a successful portfolio.

1. Meaning of Return

Return represents the total gain or loss experienced on an investment over a specific period. It is usually expressed as a percentage of the amount invested.

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Important

Key Concept: From an investor's perspective, return is the compensation for the time value of money (the wait) and the risk (the uncertainty) associated with the investment.

Simple Return Example

Initial Investment:₹100
Final Amount:₹110
Formula: (Final - Initial) / Initial * 100
Result: 10%

A ₹10 gain on a ₹100 base results in a 10% return.

2. Types of Return

Returns can be categorized in several ways depending on how they are calculated or perceived.

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Other Common Classifications:

  1. Absolute Return: The total percentage gain or loss. (e.g., "I earned 15% this year").
  2. Relative Return: Performance compared to a benchmark like the Nifty 50 or S&P 500. (e.g., "The market rose 10%, but I earned 15%, so my relative return is +5%").
  3. Nominal Return: The return before adjusting for inflation.
  4. Real Return: The return after subtracting the inflation rate.
    Tip

    Real Return ≈ Nominal Return − Inflation Rate. This is what actually increases your purchasing power.

3. Importance of Return in Investment Decisions

Why is the calculation of return so critical?

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Key Drivers:

  • Goal Tracking: Returns help you know if your portfolio is on track to buy a house or fund an education.
  • Compound Interest: Understanding returns allows you to see how your money grows exponentially over time.

Exam Pattern Questions and Answers

Question 1: "Define Return. Explain the difference between Realized and Expected Return." (5 Marks)

Answer: Definition: Return is the profit or gain made from an investment over a period. It is the reward for sacrificing current consumption and accepting risk.

Difference:

  • Realized Return: It is the historical or "actual" return that has already been earned. It is known with certainty.
  • Expected Return: It is the return an investor hopes to earn in the future. It is uncertain and is typically calculated as a weighted average of possible outcomes based on probabilities.

Question 2: "Why is it important to distinguish between Nominal and Real returns?" (4 Marks)

Answer: It is crucial because Nominal Return only shows how much the rupee amount has grown, but it ignores the rising cost of living. Real Return accounts for inflation and represents the actual increase in the investor's purchasing power. If an investor earns 10% nominal return but inflation is 12%, they are actually losing 2% in "real" value.

Summary

  • Return is the primary motive for investing.
  • Realized Return is past data; Expected Return is future estimation.
  • Real Return is the true measure of wealth growth after inflation.
  • Returns are essential for evaluation, comparison, and planning.

Quiz Time! 🎯

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