Return on Portfolio 💰📊
In Unit I, we learned how to calculate the return of a single asset. But in a portfolio, you have many assets. How do you combine them? The return of a portfolio is simply the weighted average of the returns of the individual assets in that portfolio.
1. The Concept of Weights
A "Weight" represents the percentage of your total money invested in a specific asset.
Weight of Asset A (Wa) = Amount Invested in A / Total Portfolio Value
Important
The sum of all weights in a portfolio must always equal 1.0 (or 100%).
2. Formula for Portfolio Return
To find the total return, you multiply the return of each asset by its weight and add them up.
Rp = (Wa * Ra) + (Wb * Rb) + ... + (Wn * Rn)
Where:
- Rp: Expected return of the portfolio.
- Wa, Wb: Weights of assets A and B.
- Ra, Rb: Expected returns of assets A and B.
Portfolio Return Calculation
| Stock X (Return 15%) (Wx=0.6) | 9.00% |
| Add: Stock Y (Return 10%) (Wy=0.4) | 4.00% |
| Total Portfolio Return | 13.00% |
4. Key Takeaways
- Direct Relationship: If you increase the weight of the higher-returning asset, the portfolio return moves closer to that asset's return.
- No Magic: You cannot get a portfolio return higher than your best asset or lower than your worst asset.
- Simplicity: Unlike risk (which we will learn next), return calculation is straightforward addition.
Step 1"Identify the return of each individual asset."
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Step 2"Calculate the weight (proportion) of each asset."
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Step 3"Multiply weight by return for each asset."
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Step 4"Sum the results to get the Portfolio Return."
Summary
- Portfolio return is a weighted average.
- Weights depend on the rupee amount invested.
- Formula: Rp = Sum of (Weight * Return).
- It is the easiest part of portfolio analysis!
Quiz Time! 🎯
Test Your Knowledge
Question 1 of 4
1. The sum of all weights in a portfolio must always equal: