If you are interested in the world of investments, it is key that you keep a record of the profitability that your assets generate each year. This way, when someone asks you: ‘How much have you earned investing’, you will be able to have an answer based on your accumulated profitability.
The accumulated return is nothing more than the total gains obtained from an investment since it was made. For example, if you invested $10,000 in a mutual fund that has grown by 30% over the past three years, your cumulative return would be $3,000, resulting in a total value of $13,000. This calculation includes not only the initial gain, but also any interest or dividends generated over time.
Why is it important to understand cumulative profitability?
This is a metric that any smart investor should be aware of. Through this metric, investors can assess the real performance of their assets over time. Very different from the simple return, which only calculates the gain or loss of an investment without considering the impact of compounding, the accumulated return takes into account the interest generated on previous interest, making it a much more accurate indicator of a portfolio’s performance.
Similarly, it also considers the length of time the investment has been held and the effects of compounding. This allows investors to gain a more comprehensive understanding of their performance and, consequently, make more accurate and strategic decisions about their future investments.
Key factors influencing cumulative profitability
In order to optimize your investments and know in which vehicles to deposit your money, it is key to understand which factors affect the accumulated profitability. The most important ones will be described below:
Investment period
The duration of the investment is a crucial factor in understanding the performance of the accumulated return. The longer the investment period, the greater the likelihood of capital appreciation. This is because time allows one to take advantage of the effect of compound interest, which is the ability to earn interest on previously earned interest.
Investors who choose long-term strategies can benefit from the general trend of market growth, which translates into more favorable returns. In contrast, those who opt for short-term investments often face greater volatility and uncertainty, which can negatively impact their cumulative returns.
Frequency of capitalization
Interest can enhance your investments if you capitalize your earnings. That is, instead of withdrawing the interest earned, it is reinvested in the same asset or in other financial vehicles. This compounding can be done on a monthly, quarterly or semi-annual basis.
The higher the frequency of compounding, the higher the accumulated return can be. This is because more frequent compounding allows the interest earned to be added to the base capital more quickly, which in turn increases the amount on which future interest will be calculated. For example, an investment that compounds monthly will generate more return than one that compounds annually, since compound interest will be applied multiple times during the year.
Market volatility
Before initiating any investment, it is critical that investors understand the nature of the market in which they are participating and how fluctuations can impact their performance. Investing in a highly volatile environment means that asset values can experience dramatic changes over short periods of time, which in turn can negatively impact cumulative returns.
Volatility can be caused by a variety of factors, including economic, political or social changes, and can create uncertainty for investors. In such scenarios, asset prices may fluctuate, which can make long-term performance predictability difficult.
Commissions and associated costs
Investment-related fees and associated costs can negatively impact cumulative returns. Therefore, it is critical that investors carefully evaluate all costs that may arise when selecting a financial vehicle to invest their capital. This includes not only buying and selling commissions, but also management fees, administrative expenses and any other hidden costs that may arise during the life cycle of the investment.
A thorough analysis of these costs is essential, as even seemingly small fees can add up and significantly reduce returns over time. As an example, a mutual fund with a high management fee may offer attractive gross returns, but its costs can erode much of those returns, affecting cumulative performance negatively.
How to make a cumulative profitability calculation?
Now that you understand the importance of understanding cumulative returns for projecting the performance of your investments, it is essential to learn how to calculate them. Although there may be variations in the method of calculation depending on the type of return you are evaluating, the basic principle is similar.
The general formula for calculating the cumulative return is as follows:
(Present value of the investment: Initial value of the investment) / Initial value of the investment * 100
Let us apply the cumulative return formula using an example with an initial capital of 100,000 euros.
Let us assume that the present value of the investment is 120,000 euros. Using the formula, it would be as follows:
Accumulated profitability = (120.000−100,000 / 100,000) x 100
Accumulated profitability = (120.000 / 100,000) x 100
Accumulated profitability = (0.2% x 100,000) = 20%
As seen in this example, the cumulative return on an initial investment of 100,000 euros, which has grown to 120,000 euros, is 20%. This means that the investment has generated a return of 20% on the initial capital.
This is a simple return that often for a portfolio will not reflect the real return due to the inflows and outflows of capital. In these cases, the correct return is the calculation of time-weighted return (TWR) or money-weighted return (MWR), as both consider these cash flows and their impact on the total investment performance.
To learn more about these methods, we invite you to read our articles:
Maximize the cumulative return of your investments with inbestMe
Through a careful selection of financial products, inbestMe is an investment platform that offers its users tools to optimize costs and manage their investments efficiently.
The platform has a wide range of products adapted to different risk profiles and investment objectives, allowing investors to find the options that best suit their needs and, thus, increase their chances of achieving a higher cumulative return.
It is an automated system and, in this regard, focuses on reducing the costs associated with investments, a key factor in maximizing cumulative returns.
In addition, it provides customized investment strategies that consider market volatility and other indispensable factors. This empowers investors to make informed decisions and adapt to changing market conditions, which is crucial to maintaining and increasing cumulative returns over time.
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