What's the difference between absolute and relative return?

By Investopedia Staff AAA
A:

Knowing whether a fund manager or broker is doing a good job can be a challenge for some investors. It's difficult to define what good is, because it depends on how the rest of the market has been performing. For example in a bull market, 2% is a horrible return. But in a bear market, when most investors are down 20%, just preserving your capital would be considered a triumph. In that case, 2% doesn't look so bad.

So, the absolute return is simply whatever an asset or portfolio returned over a certain period. In the paragraph above, the 2% we mentioned would be the absolute return. If a mutual fund returned 8% last year, then that 8% would be its absolute return. Pretty simple stuff.

Relative return, on the other hand, is the difference between the absolute return and the performance of the market (or other similar investments), which is gauged by a benchmark, or index, such as the S&P 500. Relative return is the reason why a 2% return is bad in a bull market and good in a bear market. (If you aren't familiar with indexes, read more on them in our Index Investing tutorial).

Relative return is important because it is a way to measure the performance of actively managed funds, which should get a return greater than that of the market. After all, you can always buy an index fund that has a low management expense ratio (MER) and will guarantee the market return. If you're paying a manager to perform better than the market and the investment doesn't have a positive relative return over a long period of time, it may be worth your time shopping around for a new fund manager.

Absolute return does not say much on it's own. You need to look at the relative return to see how an investment's return compares to other similar investments. Once you have a comparable benchmark in which to measure your investment's return, you can then make a decision of whether your investment is doing well or poorly and act accordingly. (For further reading on returns, check out our article The Truth Behind Mutual Fund Returns.)

RELATED FAQS

  1. What are the best ways to lower my investing fees?

    Lower your investing fees by buying index funds or ETFs, choosing the right mutual fund share class, evaluating breakpoints ...
  2. Can you buy shares in the Dow Jones Industrial Average (DJIA)?

    Invest in the Dow Jones Industrial Average index through index funds or ETFs.
  3. Is it possible to beat the market?

    "Beating the market" means trying to earn an investment return greater than that of the S&P 500 index, one of the most ...
  4. Where do most fund managers get their market information?

    Many fund managers, whether they manage a mutual fund, trust fund, pension or hedge fund, have access to resources that the ...
RELATED TERMS
  1. Steve Cohen

    A trading magnate also referred to as the Hedge Fund King and ...
  2. David Tepper

    A legendary investor who specializes in distressed debt and manages ...
  3. David Einhorn

    Known for his short selling strategy, activist investor David ...
  4. Subprime Meltdown

    The sharp increase in high-risk mortgages that went into default ...
  5. Volcker Rule

    The Volcker rule separates investment banking, private equity ...
  6. Relative-Value Funds

    A hedge fund that seeks to exploit differences in the price or ...
comments powered by Disqus
Related Articles
  1. Choosing The Right ETF Index To Reach ...
    Investing News

    Choosing The Right ETF Index To Reach ...

  2. Hedge Fund Fees: Exotic Expenses
    Investing Basics

    Hedge Fund Fees: Exotic Expenses

  3. What You Need To Know About Financial ...
    Insurance

    What You Need To Know About Financial ...

  4. IRA Assets And Alternative Investments
    Retirement

    IRA Assets And Alternative Investments

  5. Green Investors Get Heard
    Insurance

    Green Investors Get Heard

Trading Center