The world of investment is quantitative one. Answers to questions that ask ‘how much’ are always a lot more useful than those that ask ‘what’ or ‘how’? Unfortunately, only professional investors seem to regularly ask these ‘how much’ questions of their investments. Individuals rarely bother to get precise answers to how well their investments are doing in a way by which they can compare different investments. They always have a precise idea of how much their bank and other deposits are earning because that’s fixed and it’s stated upfront. But for stocks, funds, and even real estate, people rarely have an idea of how much the comparable per annum rate of return is.
Someone I know bought an apartment for Rs 21 lakh in 1997 and sold it for Rs 95 lakh a few months back. This appeared to be a great bonanza to him. However, the annual rate of return comes to 12 per cent. Over the same period, the BSE Sensex returned 12.9 per cent and an SIP returns in a Sensex-tracking fund would have been 18.1 per cent. I think investors pay a high price for not doing a little bit of work on acquainting themselves with the arithmetic of calculating and comparing investment returns.
The above example is somewhat extreme but the effect on understanding is just as lethal over shorter periods. Say you invest in a stock three or four times (different amounts at different prices) over a year and book profits once. Over the same period, you have an SIP running in an equity fund. Could you actually calculate the two investments’ rate of return in order to compare them? In fact, unless one was overwhelmingly better than the other, you may not even be able to figure out which was better.
Unfortunately, there’s no straightforward formula you can use for paper-and-pen calculations. There are two ways of doing this. One, use a spreadsheet program like Microsoft Excel or OpenOffice Calc and learn how to use the functions for internal rate of returns—there’s plenty of help on the internet. Or two, use an online portfolio manager which does the calculations for you. Preferably you should learn the first and then use the second for convenience.