Calculating cumulative investment returns over time is crucial for investors to track performance and make informed decisions. The cumulative return formula sums the performance of an investment over a period of time. By using this formula, investors can evaluate how their investments have performed on a cumulative basis rather than just looking at periodic returns. Here are some key things to know about calculating cumulative investment returns.
Understand what cumulative return is
Cumulative return is the total return on an investment over a specified period of time. It captures the compounding effect of investment gains and losses over multiple periods. For example, if an investment returns 5% in year 1 and 10% in year 2, the cumulative return over the 2 years is 15.5% (1.05 * 1.10 – 1 = 0.155). Unlike periodic returns, cumulative returns allow you to evaluate the total performance of an investment over time.
Use the cumulative return formula
The cumulative return formula is: Cumulative Return = (Ending Value / Beginning Value) – 1. Where: Ending Value = ending value of the investment. Beginning Value = beginning value of the investment. For example, if you invested $10,000 and it grew to $15,000 over 5 years, the calculation is: Cumulative Return = ($15,000 / $10,000) – 1 = 0.5 = 50%. This shows your total return was 50% over the 5 year period.
Calculate annualized return
While cumulative return shows total performance, annualized return allows you to compare returns over different time periods. To annualize the cumulative return: Annualized Return = (Cumulative Return + 1)^(1/n) – 1. Where n is the number of years. Using the previous example, the annualized return is: (1.5)^(1/5) – 1 = 8.7%. This shows your average annual return was 8.7%.
Use spreadsheet functions
Many spreadsheets have built-in functions to easily calculate cumulative and annualized returns. For example, in Excel you can use the CUMIPMT() function for cumulative return and the RRI() function to annualize the return. While not required, using spreadsheet functions can save time and avoid potential errors in manual calculations.
Regularly monitor cumulative returns
It’s important for investors to regularly monitor the cumulative performance of their investments, such as every quarter or year. This provides a clear picture of how an investment has done over time, rather than just looking at periodic returns. Comparing the cumulative returns of different investments also helps with performance evaluation and future allocation decisions.
The cumulative investment return formula sums total returns over a time period to capture compounding effects. Investors should use this formula, along with annualized returns, to evaluate investment performance over both short and long horizons. Regularly monitoring cumulative returns is key for making informed investment decisions.