Have you heard people talking about their real estate investments, “I bought that house for 30 lakhs in 2004. It’s worth 1.2 cr today! It has grown 4 times in 15 years.” This is an example of an absolute return.
When you compare the final value of an investment with the price at which you invested in it, the growth experienced over time is a measure of absolute return.
For instance, you invested Rs. 5000 in a fund say 5 years back. If the value of your investments is Rs. 6000 today, you made a gain of Rs.1000 which is equal to an absolute return of 20% on your initial investment of Rs. 5000.
The drawback of absolute return is it doesn’t take the time period into consideration. In the above case a return of 20% sounds good. But when it is achieved over 5 years, does it seem attractive? But if you calculate the average annual return for the 5-year period (CAGR), it is only 3.7%. Absolute return is used to calculate returns from funds that are less than a year old. In all other cases annualized return (CAGR) is used which gives the average annual return earned by an investment over a given time period.