Financial returns

Everyone invests to improve their financial situation by either growing a solid portfolio, growing wealth or seeing sizable returns from their investment. For this reason, understanding how financial returns work is very important.


Financial returns definition

A financial return, or simply a return, is money made or lost on an investment over a specified period. Returns can be expressed as the currency change in the value of an asset or as a percentage of the gain or loss.

Financial results can also be expressed as net returns by subtracting fees, inflation, and taxes from the gross return.

Financial retail can be positive, representing a profit, or negative, representing a loss.

What factors affect investment returns?

The first factor is asset allocation. Different assets and commodities have different returns, meaning the percentages of these assets and commodities in your portfolio will affect your returns. Asset allocation goes hand in hand with diversification, which is investing across different asset classes and within them to maximise returns while reducing risk and hedging against inflation.

The other is market conditions. These include geopolitical events, interest rates, inflation, customer apathy, and economic growth. All of these affect the performance of different industries and sectors, leading to the volatility of their underlying assets, thereby affecting your returns.

Management fees can also affect finance returns. You will have lower returns if your manager, advisor, or platform charges high fees, including hidden fees. Taxes can also impact financial returns as fees do; the higher they are, the lower your returns.

Time horizons also affect returns. Longer-term investments have been shown to have much better results than charter-term investments. However, you can balance things out by increasing your risk.

If you have a high-risk tolerance, you can invest in riskier asset classes but have the potential upside of outperforming fellow investors and the market.

What is the difference between absolute and relative financial returns?

Absolute returns measure the actual profit or loss an investment has generated over a given period.

Relative returns measure an investment’s performance compared to a benchmark or index. This benchmark could be a stock market index, such as the FTSE 100, or a specific asset class, such as bonds or commodities. For example, if the FTSE 100 increased by 15% over one year and your investment increased by 10%, your relative return would be 5% underperformance.

Absolute returns tell you an investment’s actual profit or loss, while relative returns provide context by showing how well an investment performed compared to a benchmark. Relative returns are especially useful when comparing investments with different risk profiles or in different asset classes.

What is the correlation between risk and financial returns?

Risk is the probability of losing a given amount on an investment over a given period. People with high-risk tolerances are more likely to invest in riskier investments. There is a direct relationship between risk and returns in that riskier investments typically lead to bigger returns.

However, it is crucial to understand that this relationship is not always so clear, especially in well-diversified portfolios. A well-diversified portfolio can produce the same return as a riskier investment, and this effect is magnified depending on the assets and commodities included in the diversified portfolio.

How do taxes affect returns for investors in the stock market?

The three main taxes investors must consider are capital gains, dividend and stamp duty.  An investor may be subject to capital gains tax (CGT) if they sell shares for a profit. In the UK, individuals have an annual tax-free allowance, and any gains above this amount are subject to tax at a rate depending on the investor’s income level.

As with capital gains, individuals have a tax-free dividend allowance, with any dividend income above this amount subject to tax depending on their income level.

When an investor buys shares in a UK company, they may be subject to stamp duty at a rate of 0.5% on the value of the transaction. Stamp duty is typically paid by the buyer.

All these taxes reduce the amount an investor can invest or how much return they get after selling their investments or getting a dividend.

Every investor should keep an eye on their financial returns to see whether their investors are performing as they expect. If not, they can get advice on how to ensure they do.