8% Portfolio Yield

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Recently, an interesting event took place involving a friend of mine, whom I'll refer to as AA has often encountered numerous individuals on the internet inquiring, "Where can I find investment products with an annualized return of over 6% with 1 million yuan?" or asking for capital-preserving products with annualized returns of 4%. Out of curiosity, A decided to take a look at her own investment products and was overjoyed to discover that the products she had been holding for more than three years yielded returns exceeding 8%! This led her to believe that her luck was exceptional and that she had inadvertently stumbled upon a fantastic investment opportunity.

However, savvy readers might recognize a critical distinction here: an 8% holding return does not equate to an annualized return of 8%. The holding return and annualized return are two fundamentally different concepts in the realm of investments

So, what exactly is the annualized return on A's investment?

Understanding the Difference: Holding Return vsAnnualized Return

To comprehend the difference clearly, let's break it down:

The holding return refers to the total return on an investment from the moment an investor buys a fund, stock, or other financial product until the point they assess that investment after holding it for some timeThis metric, often termed the cumulative return, fluctuates based on changes in market prices and the quantity of stocks held over time.

On the other hand, the annualized return standardizes the performance of financial products over a year, providing insights into the average return one might expect annuallyIt essentially transforms the actual returns over a specified period into an equivalent yearly rateThis means that while the holding return is a snapshot of total returns over time, the annualized return reflects how those gains would average out over a year.

To put it simply, the holding return measures the total gain or loss from an investment held for some time, while the annualized return measures that return as if it were achieved consistently over a year.

Additionally, it's crucial to grasp that the holding return may cover various time frames, while the annualized return is exclusively calculated with respect to one year

For example, if one calculates the annualized return based on recent weekly, monthly, or yearly performance metrics, those figures should accurately correspond to that timeframeUsing a seven-day return would lead to a seven-day annualized return; conversely, using a one-year return would yield a one-year annualized figure.

Here’s a key insight: If a product has delivered mediocre returns over the past year but shows significant returns in the past month, estimating its annualized return using the recent one-month performance can result in inflated expectationsThis discrepancy is why many financial institutions tend to highlight attractive annualized returns prominently, leading investors like A to purchase seemingly lucrative products only to find that the reality falls short of their initial expectations.

So, how does one go about calculating the annualized return?

For someone like A, faced solely with the knowledge of her yield performance, how can she accurately calculate the annualized return?

A popular formula often circulated online for calculating annualized return is as follows: Annualized Return = (Total Earnings / Principal Investment / Investment Duration in Days) × 365 × 100%. It is important to note that this formula calculates simple interest annualized return.

Simple interest signifies that during the investment period, the principal does not earn interest on the interest, meaning there is no compounding effect

This makes the simple interest annualized return reasonably accurate for short-term investments; however, over a longer investment horizon, the disparity between simple and compound interest becomes pronounced.

If A wishes to achieve a more accurate representation of her investment's annualized return, she should utilize the formula for compound annual growth rate (CAGR): (1 + Return Rate)^(1 / Years Held) - 1. The notation “^” signifies exponentiation.

Based on A's case, she invested 100,000 yuan and has held that investment for 1,122 days, realizing total earnings of 8,862.73 yuan.

The initial step is to calculate the return rateThis is done by dividing the total earnings by the principal investment, yielding a result of 8.86%. The second step involves determining the number of years heldThis is calculated by dividing the total investment duration in days (1,122) by 365, resulting in approximately 3.07 years.

The third and final step is inserting these values into the annualized return formula: (1 + 8.86%)^(1 / 3.07) - 1.

While the calculations may seem daunting, they can easily be handled using spreadsheet software like Excel

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