Absolute Return On An Investment

Absolute return is the measure of the profit or loss of an investment based on the amount that was invested

There are two principal ways of quantifying the return on an investment: Absolute or Relative. Absolute return is the measure of the profit or loss of an investment based on the amount that was invested or as a percentage of the invested capital.

Benchmarks are typically not considered with absolute investment expect probably that the investments should do better than government assets like Treasury Bills. Since Absolute return is measured as a percentage, computing the absolute return on an investment is as simple as finding the difference of the current value and cost value of the investment and dividing by the cost value.

It is whatever an investment asset or portfolio earned over a period of time which is usually as simple as saying you made 20% profit or 20% loss on an investment. Investors who are interested in the absolute return on an investment employ strategies geared towards producing a positive return without considering the state of the capital market itself.

Their goal is to not be affected by the usual volatility that occurs in the market; rather, they try to always be ahead of the market by taking advantages of whatever opportunities that present themselves.

For one, because they are interested in short term gains which yield little per share, they carry out a lot of trading in short periods of time. Their portfolios which are diversified enough to cut across economic cycles, asset classes, industries and so on, would have high turnover. They are always buying and selling shares and they do so more frequently than the average investor.

Because their focus is on immediate gains, short selling is only expected. The normal way to make profit from stock trading is to buy at a low price and sell at a high one but short selling involves carrying out the reverse. This strategy is used when a security’s price is expected to decline.

Another strategy employed by investors interested in absolute return is leverage. This is an investment strategy where borrowed money or capital is used to increase the potential return of an investment.

Futures and option contracts are also used. With Future contracts, the investor would agree to buy or sell something with another party at a predetermined price and at a specified time in the future. With options, the investor enters a contract that allows but doesn't require him to buy or sell a security at a predetermined price over a certain period of time.

While seeking absolute return on your investment has its advantages, it is not encouraged because of the myriad of disadvantages that the investor would be faced with.

Written by Lawretta Egba.