Which Investment Return Measure is Right for You?
Investment returns are a measure of how much money an investment has made or lost over time. They can be calculated in a number of different ways, each with its own advantages and disadvantages.
This article will explain the four most common types of investment returns:
- Normal return,
- Logarithmic return,
- Cumulative return,
- Exponential return.
We will also discuss which type of return is best for different types of investors.
Normal, logarithmic, cumulative, and exponential returns are four different methods used to measure the return of an investment over time.
- Normal return is the percentage change in the price of an investment from its starting price to its ending price. The formula is as follows:
Normal return = (ending price - starting price) / starting price * 100
For example, if the starting price of an investment is 100 TL and the ending price is 120 TL, the normal return is 20%.
- Logarithmic return is the natural logarithm change in the price of an investment from its starting price to its ending price. The formula is as follows:
Logarithmic return = ln(ending price) - ln(starting price)
Unlike normal return, logarithmic return more accurately measures the growth of an investment’s price over time.
Cumulative return is the total return that an investment has earned from its starting price. The formula is as follows:
Cumulative return = (ending price - starting price) + 1
Cumulative return is useful for seeing how much an investment has grown or shrunk over time.
- Exponential return is the compound return that an investment has earned from its starting price. The formula is as follows:
Exponential return = (ending price / starting price) ^ (1 / n)
n represents the number of times an investment’s return is annualized, which is the number of years that an investment’s return has been compounded.
Differences
The key differences between normal, logarithmic, cumulative, and exponential returns are as follows:
- Normal return measures the percentage change in the price of an investment from its starting price to its ending price.
- Logarithmic return measures the natural logarithm change in the price of an investment from its starting price to its ending price.
- Cumulative return is the total return that an investment has earned from its starting price.
- Exponential return is the compound return that an investment has earned from its starting price.
Which is better?
Which return method is better depends on the investor’s needs and goals.
- Normal return is useful for measuring the simple return of an investment.
- Logarithmic return more accurately measures the growth of an investment’s price over time.
- Cumulative return is useful for seeing how much an investment has grown or shrunk.
- Exponential return is useful for measuring the compound return of an investment.
In summary :
Generally, normal return is a better measure for short-term investments.
Logarithmic return is a better measure for medium-term investments.
Cumulative return is a better measure for long-term investments.
Exponential return is always a good measure for measuring compound return.
Additional notes:
- Normal return is the most commonly used return method. It is simple to calculate and understand.
- Logarithmic return is more accurate than normal return for measuring the growth of an investment’s price over time. This is because logarithmic return takes into account the compounding effect of interest.
- Cumulative return is a good measure for seeing how much an investment has grown or shrunk over time. It is also useful for comparing the performance of different investments.
- Exponential return is the most accurate return method for measuring the compound return of an investment. It is also useful for calculating the future value of an investment.
