The Economic Return of Investing is a crucial ratio for investors, providing insight into the profitability of their investments. This ratio helps investors assess their earnings by considering both dividends received and changes in the fair value of their investments. It is particularly useful as it allows investors to evaluate their returns without directly relying on financial statements.
To calculate the Economic Return, the formula is structured as follows:
\[\text{Economic Return} = \frac{\text{Dividends and Interest Received} + \text{Change in Fair Value}}{\text{Original Cost of Investment}} \times 100\]
In this formula, the numerator consists of two components: the dividends and interest received, which represent the cash inflows from investments, and the change in fair value, which accounts for capital appreciation or depreciation. For instance, if an investor purchases a stock for $20 and its value rises to $30, the change in fair value results in a capital gain of $10. Conversely, if the stock's value drops to $15, the investor experiences a capital loss of $5.
The denominator reflects the original cost of the investment, specifically the fair value at the beginning of the investment period. This allows investors to measure their returns relative to their initial investment. The result is typically expressed as a percentage, indicating the profit or loss per dollar invested. For example, a 5% return signifies that for every dollar invested, the investor earns five cents in profit.
Understanding the Economic Return of Investing equips investors with the knowledge to make informed decisions about their portfolios, enabling them to evaluate the effectiveness of their investment strategies over time.
