Relative Return On An Investment

With relative investment return, the success of the asset is often based on the comparison of the chosen benchmark or the overall market performance.

Let’s say you earned 20% on an investment you made last year. When you think of it absolutely, 20% isn’t a bad return to make at all. However, if other investments within the same category as yours earned 50% and above, the 20% doesn’t seem so good after all. This, in a nutshell, is what relative investment return is about.

Relative return is a measure of the return derived from an investment asset or an investment portfolio based on a benchmark or comparison tool. While returns can be defined in absolute terms without any consideration for riskiness, industry averages, and so on, an investor interested in deriving a relative return has to consider other elements.

In this case, a relative return is only seen as positive when it performs better than a defined benchmark. The return is also seen as negative when it is below the benchmark.

Relative return has also been used by fund managers to measure their performance. For example, if an investor has stakes in a mutual fund that doesn’t yield as much as the investments he carries out by himself or the market itself over a period of time, he would be forced to change the mutual fund not because the fund isn’t yielding returns at all, but because he can essentially get a better option at achieving his goals.

In other words, the success of the asset is often based on the comparison of the chosen benchmark or the overall market performance.

Another way to look at relative return is that it is heavily contextual. For example, in a bull market, an investment gain of 2% would be seen as a bad return. This is because in the bull market, large returns are being recorded daily.

However, in a bear market, 2% doesn’t suck at all because it would even be a gain to be able to keep your capital safe in the first place. As such, the relative return does not care about the value gained itself but the context in which it was gained (or lost, for that matter.)

It is relative return that makes carrying out market analysis necessary. The investor or fund manager would have to assess market trends to see past performance. They would also make projections of future performances based on economic indicators and perform economic analysis on specific companies or stocks within the same industry to create an acceptable benchmark.

The first advantage of the relative investment is that it helps the investors to immediately assess the prospect of an investment to know if it would be worthwhile, if they need to invest more, and generally the kinds of investment decisions to make.

It also helps you measure the potential returns on other investment opportunities as well. This way, you are not blind to the opportunities around you. With this, an investor can determine the strengths, weaknesses, opportunities, and threats to his investment.

However, overly assessing your investment might make you impatient and too wary of the market. There are a number of factors to consider when reviewing your investment returns. They would be highlighted in our next post.

Written by Lawretta Egba.