OT: Rate of Return Calculations, Big brain Fart Options

[Qarl]

Let's say I invested $1000 in a mutual fund on November 1, 2002

At the end of April of 2005, it is worth $1450.

My gain is $450 or 45% since I purchased it.

But how do I calculate how much average annual return it has been for the 30 month period. Or in other words, it's equivalent to an investment making X% a year?

What's the formula?

Thanks....

[airsix]

QUOTE (Carl @ May 13 2005, 08:54 AM)

OK, I'll bite.  Ben, please explain calculation of downside risk ..

The technical term is 'Value at Risk' (VAR). Basically it's a statistical measurement used to measure the risk of an investment losing value over a specific period of time. The three components are time, confidence level, and loss percentage. Typically you choose a time interval (day, month, year, ...), a confidence level ("I want to know with 95% confidence"), and one of three variability measurement types (historical data, variance-covariance, or Monte Carlo simulation). Typically the variance-covariance method meets my needs and is less subjective in my opinion.

For regulatory reasons I'll use a purely hypothetical example using an imaginary investment, and calculate 12-month VAR with a confidence level of 99%.

Average annual return = 10.88%
1yr standard deviation = 13.10

VAR = (ave. return)+[(-1 x standard deviations for selected % certainty)x(standard deviation)]
VAR(12mo.) = 10.88% + (-2.33 x 13.1%) = -19.64%

In other words, 12mo. losses (for this imaginary investment) can be expeted to not exceed -20% most of the time for any 365 day period. Rather than just looking at the average return and saying "I ought to make 10% over the long haul" you have to realize that over a short period - 1yr in this example - you could likely see a loss of 20% in this example. VAR calculation can be performed against a single investment or an entire portfolio.

What this does is give us an indicator of potential losses over the selected time period (in this case 12 months). This is strictly a risk-evaluation tool. It can't predict the future. It is based on past performance and variability, which is not an indicator of future returns.

What I often see when meeting with an investor for the first time is that they are exposed to a higher level of downside risk than they realize.

If that was too much or not enough info I appologize. (IMG:http://www.914world.com/bbs2/html/emoticons/smile.gif)

-Ben M.