The right way to calculate investment returns

99% are calculating it the wrong way!

This writeup is for the privileged lot who subscribed to the email newsletter as this will give you a sneak peak into the detailed video that will be uploaded next week. I will talk about 3 friends in that video with their investments in different properties and will try to find out how has been their investment profited for the length of the property ownership.

For this newsletter we will take one example from it – where one of those friends booked a plot back in 2009 and paid for multiple installments and fees related to it over the last decade before selling it in 2020. The total payments against that plot are illustrated in the table below:

Payment plan of the plot along with selling details

The above table has all the payments mentioned in negative as they are all cash flow negative meaning that the amount has got out of the pocket! The total amount invested is 2,398,929/- PKR over the 11 years period.

At the same time – the plot was sold in Aug-2020 which is a cash flow +ve item as the amount comes into the pocket.

Now – in case we want to know what is the annualized rate of return for the investment, the process becomes complicated as the amount paid is spread over a decade and conventional method of calculating rate of return will give you wrong value and perception.

BTW, to start with, why actually you need an annual rate of return for any investment? The reason is that it is the best way to reflect on investment return over a fixed period of time and can be benchmarked for other investments comparison.

Calculation approach # 1:

So – if we consider calculating the returns, the easy way for us to calculate is:

Current or present value minus the original value divided by the initial value, times 100

which will translate to [(9,600,000 – 2,398,929) / 2,398,929 ] x 100 = 300%.

The return calculated this way gives a value of 300% – however, this calculation does not take into account the payments that were made over a period of time and not just in one go – the 300% infact points towards huge returns if the plot increased in value within last 1 year as the formula in no way has a way to include the duration of investment (which in this case is 11 years).

Calculation approach # 2:

This brings to another way, where if we find CAGR (Compounded Annual Growth Rate) – which although is not the scope of this writing, but let me briefly touch upon, it will produce a result of 13% [Using the excel formula of RRI, which gets you CAGR, It takes into account how much time has passed since the investment is made].

However, this method has inherent flaw too – which also misses all the payments in between and only considers that full payment was made 11 years back.

The above two methods are good for taking out absolute returns if there is no intermediate payment involved [or for that mater even a +ve cash flow occurs]. This brings us to find a way to incorporate all the payments we do for any investment throughout the lifetime and take the returns at the end – or even any time during the considered duration.

Calculation approach # 3:

Now – excel gives us a very good and simple tool to overcome this issue. Using a simple formula of XIRR (Extended Internal Rate of Return) – that will give you the exact annualized rate of return for your investment. So, lets see the table once again with the formula for the above table:

The table above demonstrates how to get the XIRR for the investment and the excel format can be seen in the formula bar to calculate simple yet powerful method to calculate the actual annualized rate of return for the investment – which in this case is a whopping 29%. I will explain this example further in the upcoming video along with other 2 examples which includes an apartment that was booked in 2008 and got delivered in 2018 and since then is rented out – this is an exciting calculation which is supposed to be very complicated, but once you see the video – you will thank excel for making things so simple! I will add the link to the excel sheet in the description on the video when it comes out – so keep tuned on YouTube 🙂

Besides this, the cool formula also can give you the exact picture of any kind of investments return – I did the same for a stock I owned which when calculated gave me 89% annualized return within 3 months of owning. Will be making a video on that too. STAY TUNED!

The 3 videos in last week in case you missed: