👋 Today, let’s dive into a crucial investment concept that often buzzes around in the finance world but isn’t always clear to everyone – the difference between Absolute and Relative Return. 📊🔍
Absolute Return: Consider this as the ‘independent thinker’ of investment returns. Regardless of market trends or benchmarks, it’s all about the actual gain or loss your investment makes. Simply put, if you invest $1,000, which grows to $1,100, your absolute return is a positive 10%. It’s a straight-up measure of success, aiming for positive returns no matter the market climate. 📈
Relative Return: Imagine a race where your investment is pitted against a specific benchmark or index. This is where relative return comes into play. It’s all about comparison. If your investment grows by 10%, but the benchmark grows by 12%, your relative return is actually -2%. It’s like saying, “It’s not just about how well I did, but how well I did compared to others.” 🏁
Both approaches have their merits. Absolute return seeks to avoid losses and generate positive returns in all market conditions. Relative return, on the other hand, aims to outperform a benchmark, making it a game of strategic market navigation. 🌊⛵
But wait, there’s more! In the vast ocean of investment strategies, other principles also play pivotal roles:
Risk-Adjusted Return: This one puts your returns in perspective by considering the risk involved in achieving them. Higher returns might look great, but are they worth it if they come with high risk? 🤔
Total Return: This includes all sources of return – capital gains, dividends, and interest. It’s the ‘all-inclusive package’ of investment returns. 🎁
Alpha and Beta: Alpha measures performance on a risk-adjusted basis, while Beta indicates the volatility of an investment relative to the market. They’re like the dynamic duo of measuring investment performance. 🦸♂️🦸♀️
Understanding these concepts can be a game-changer in your approach to investing. So, which one resonates with you? Absolute, Relative, or a mix of different strategies?
Source: LinkedIn
Three years, two perspectives (illustrative)
| Year | Portfolio | Benchmark | Absolute return | Relative return |
|---|---|---|---|---|
| Strong market | +8% | +10% | +8% | −2 percentage points |
| Falling market | −5% | −15% | −5% | +10 percentage points |
| Flat market | +3% | +3% | +3% | 0 percentage points |
The same portfolio looks disappointing in the first year and excellent in the second, depending on the lens. A client who lost 5% will rarely celebrate the relative outperformance, even if it was a good result.
Which lens fits which client?
- Absolute return suits clients with a concrete goal: preserving capital, funding a lifestyle or meeting a liability. What counts is the actual change in wealth.
- Relative return suits clients who accept market risk and want to know whether their manager adds value compared with a passive alternative.
- Most mandates combine both: a target return or risk budget, measured against a reference benchmark.
Agree on the yardstick upfront
Many disappointments in wealth management come from unclear expectations. Before a mandate starts, client and manager should agree on the benchmark, the time horizon and the acceptable drawdown. A performance report then answers the question the client actually cares about.
Frequently asked questions
What is a good benchmark for a balanced Swiss portfolio?
A mix of indices that reflects the portfolio’s strategic allocation, for example Swiss and global equities and bonds in CHF, weighted like the target allocation.
What does alpha mean in practice?
The return achieved beyond what the market exposure alone would have delivered. Positive alpha after costs is rare and valuable.
Related: Discretionary vs Advisory Mandates.
Whichever return style you choose, time does the heavy lifting: our compound interest and returns calculator shows how yearly returns add up over decades.
Source: https://vapa.ch/unlocking-the-secrets-of-investment-success-absolute-vs-relative-return-%f0%9f%9a%80-%f0%9f%8c%9f/ · vapa.ch
