Historical returns

Definition

Historical returns refer to the actual gains or losses made on an investment over a specific period in the past, expressed as a percentage of the initial investment. Understanding historical returns is crucial for evaluating an investment's performance and predicting future potential, as they provide insight into how assets have performed under various market conditions and can help assess risk and return trade-offs.

5 Must Know Facts For Your Next Test

1. Historical returns are typically calculated over various time frames, such as daily, monthly, or annually, allowing for different perspectives on performance.
2. Investors often compare historical returns to benchmarks to gauge how well an investment has performed relative to its peers.
3. Positive historical returns can indicate a well-performing investment, but they do not guarantee future performance due to changing market conditions.
4. Historical returns can be used in risk assessment, as investments with high volatility may show significant historical returns but also come with increased risk.
5. Financial analysts often use historical returns in modeling and forecasting future investment performance to aid in decision-making.

Review Questions

• How can historical returns be used to evaluate the performance of an investment?
  • Historical returns are essential for assessing an investment's performance by providing data on how it has performed over time. By analyzing these returns, investors can determine if an asset has consistently generated profits, experienced losses, or been volatile. Comparing these results against benchmarks allows for a deeper understanding of whether the investment is performing well relative to similar assets.
• What role do historical returns play in risk assessment for investors?
  • Historical returns play a vital role in risk assessment by helping investors understand the potential risks associated with an investment. Analyzing past performance allows investors to identify patterns of volatility and gain insights into how the asset reacted during different market conditions. This information helps investors make informed decisions about whether the potential returns justify the risks involved.
• Evaluate how historical returns might influence an investor's future strategy and decisions regarding asset allocation.
  • Historical returns significantly influence an investor's future strategy and decisions about asset allocation by providing empirical evidence of past performance. Investors analyze these returns to identify trends that inform their approach to diversification and risk management. For example, if certain asset classes consistently deliver strong historical returns with manageable volatility, an investor may decide to allocate a larger portion of their portfolio to those assets while balancing their exposure with more conservative investments based on historical performance data.

Related terms

Capital Asset Pricing Model (CAPM): A financial model that establishes a relationship between the expected return of an asset and its risk, often used to determine the required return based on historical returns.

Benchmark: A standard or point of reference against which the performance of an investment or portfolio can be measured, often using historical returns of similar assets.

Volatility: A statistical measure of the dispersion of returns for a given security or market index, indicating how much the price of an asset fluctuates over time.