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What is Portfolio Return?
Portfolio Return refers to the loss or gains realized by a portfolio of investment containing several types of investments. Portfolio Return aims to meet the preferred benchmarks, meaning a well-diversified portfolio of stock/bond holdings or a given mix of the two asset classes. Portfolios aim to deliver returns based on the promised investment strategy objectives, and the risk tolerance.
Investors typically are interested in one or more sets of portfolios and their aim is to get a balanced return back over time. Many types of portfolios are available to investors right from equities, debt to Balanced Fund consisting of a mix of shares, bonds, and cash. Portfolios may include international stocks, and some may primarily focus on geographic regions.
The formula for portfolio returns is −
$$\mathrm{𝑅_{𝑃} =\displaystyle\sum\limits_{i=1}^n 𝑤_{𝑖}𝑟_{𝑖}\:\:\:where\displaystyle\sum\limits_{i=1}^n 𝑤_{𝑖}=1}$$
"w" gives the weights of each asset and "r" is the returns on the assets.
For example, if an asset has 25% of the portfolio, its weight will be 0.25. The most notable fact to consider here is that the sum of all the asset percentages will be equal to 100%, and the sum of all asset weighs will be 1. The returns considered here are single period returns with the returns in the same period for the assets.
Example
Here’s an example of a two-asset portfolio to show how portfolio returns are calculated. Let’s suppose that the portfolio comprises of two assets A and B with the following details.
| Invested Amount | Return | |
|---|---|---|
| Asset A | 25,000 | 10% |
| Asset B | 75,000 | 6% |
The table provides the amount invested in each asset and the returns obtained from each of the assets. The total amount invested is INR 100,000.
Then, the weights for each asset as follows −
$$\mathrm{𝑤_{𝐴} =\frac{25,000}{1,00,000}= 0.25}$$
$$\mathrm{𝑤_{𝐵} =\frac{75,000}{1,00,000}= 0.75}$$
Now, let us calculate the portfolio return.
$$\mathrm{𝑅_{𝑃} = (0.25 × 10 \%) + (0.75 × 6\%) = 7\%}$$
The same calculation can be applied for more number assets in a portfolio.
Considerations
Most portfolios are usually diversified to protect against the risk of losses arising from single securities or class of securities. Here’s where the portfolio analysis comes in handy because it consists of analyzing the portfolio as a whole rather than relying exclusively on individual securities.
The risk-return profile of a portfolio depends on the component securities, their mixture or allocation, and on their degree of correlation.
A growth-oriented portfolio is a set of investments selected for their price appreciation potential, while an income-oriented portfolio is made up of investments selected for their currently generated income of dividends or interest.
An efficient portfolio consists of assets providing the greatest return for the greatest amount of risk, or — alternatively stated — the least risk for a given return. To create an efficient portfolio, one needs to know how to calculate the returns and risks of a portfolio, and how to lower the risks through diversification.
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