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. How much variance should an investor have in an indexed fund?

    Learn more about the significance of variance in index funds, its value as a measure of volatility and other common analytical ...
  2. How much of the asset management industry has moved from traditional managers to ...

    Learn about the growth of the hedge fund and alternative asset management industry and the change in regulations, preferences ...
  3. What are some of the best small cap index funds?

    Learn about the best small-cap index funds, such as the iShares Russell 2000, IWM due to its low costs; liquidity; and diversification.
  4. What's the difference between a collateralized debt obligation (CDO) and a collateralized ...

    Find out how a collateralized mortgage obligation (CMO) is similar to a collateralized debt obligation (CDO), as well as ...
RELATED TERMS
  1. Hedge Fund

    An aggressively managed portfolio of investments that uses leveraged, ...
  2. Return Over Maximum Drawdown (RoMaD)

    Return over Maximum Drawdown (RoMaD) is a risk-adjusted return ...
  3. Next Generation Fixed Income (NGFI) Manager

    A Next Generation Fixed Income (NGFI) manager is a fixed income ...
  4. Next Generation Fixed Income (NGFI)

    Next generation fixed income is an innovative approach to investing ...
  5. Annual Crediting Cap

    The maximum rate of index growth that an annuity will be credited ...
  6. Steve Cohen

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

You May Also Like

Related Articles
  1. Options & Futures

    Key Factors Of The Russell 2000 Index

  2. Professionals

    Should Investors Nix Actively Managed ...

  3. Mutual Funds & ETFs

    ETF Bubble Or No Bubble?

  4. Mutual Funds & ETFs

    These 4 Precious Metals ETFs Help Combat ...

  5. Trading Strategies

    A Legendary Market Skill Experience ...

Trading Center