People invest because they hope and expect to earn a satisfactory return on their investment. The expected return on an investment is a key factor in determining its relative attractiveness.
Return generally takes two forms:
- Current income
- Price appreciation
Some investments are structured to yield periodic and relatively dependable income payments (such as dividends, interest) while other investments are structured to provide returns primarily in the form of price appreciation (such as shares). Many investments offer both current income as well as expected price appreciation.
| Determining an Investment’s Overall Return |
|---|
| Periodic payments: dividends, interest, or rent |
| Changes in market value: capital gains or losses |
HPR = [current value of investment + income received]/initial value of investment]
The overall profitability of an investment is often expressed in the form of relatively simple concept called the Holding Period Return (HPR) which relates the profit on an investment directly to its beginning value. It is calculated in the following manner:
Example:
If an investment is purchased for Rs.100, has paid Rs.10 in dividends, and is now worth Rs.150, its holding period return is computed as follows:
HPR = [Rs.150 (current value) + Rs.10 (dividend)] / Rs.100 (initial value)
HPR = 1.6
In other words, this investment is now worth 1.6 times its initial cost. Mathematically, HPR is simply HPR minus 1 since “1” reflects the initial amount invested. Therefore, the above return equates to 60% (1.6-1 = 0.6)
Following table shows the type of return generated by the various asset classes:
| Asset Class | Income | Capital Gain |
|---|---|---|
| Shares | X | X |
| Bonds | X | X |
| Bank Deposits | X | |
| REITs | X | X |
| Mutual Funds | X | X |
| Pension Funds | X | |
| Futures Contracts | X |
