Calculating Your Portfolio Return: Weights and Individual Investments

Imagine you’re creating a delicious fruit salad. You’ve got different kinds of fruit – let’s say apples, bananas, and oranges. Each fruit represents a different investment in your portfolio. Just like you might use different amounts of each fruit in your salad, in a portfolio, you allocate different percentages to various investments. These percentages are what we call ‘weights’.

For example, if your fruit salad is half apples, a quarter bananas, and a quarter oranges, then the ‘weight’ of apples in your salad is 50 percent, and the weight of bananas and oranges is 25 percent each. In a financial portfolio, these weights represent the proportion of your total investment that is allocated to each asset. So, if you have a portfolio of 1000 dollars, and you allocate 50 percent to stocks, 25 percent to bonds, and 25 percent to real estate, then you have 500 dollars in stocks, 250 dollars in bonds, and 250 dollars in real estate. These percentages are the weights of each asset class in your portfolio.

Now, each fruit in your salad, or each investment in your portfolio, will have its own performance. Let’s say over a certain period, the price of apples increases by 10 percent, bananas increase by 5 percent, and oranges stay the same, meaning a 0 percent change. These percentage changes represent the ‘returns’ of each individual investment. Return simply means how much your investment has grown or shrunk over a period of time, expressed as a percentage of your initial investment. A positive return means your investment has grown, and a negative return means it has shrunk.

To find out the overall return of your fruit salad portfolio, or your financial portfolio, you can’t just simply average the individual fruit or investment returns. Why not? Because you have different amounts of each fruit or investment. Just like a fruit salad that’s mostly apples will be more influenced by the apple flavor than a salad with just a few apples, a portfolio heavily weighted in one investment will be more influenced by that investment’s return.

This is where the concept of ‘weighted average’ comes in. To calculate the portfolio return, you need to consider both the individual returns of each investment and their respective weights in the portfolio. Think of it like this: the apples, which make up half your salad, contributed a 10 percent gain on their portion. The bananas, making up a quarter, contributed a 5 percent gain on their portion. And the oranges, also a quarter, had a 0 percent change, contributing nothing to the gain.

To calculate the overall fruit salad portfolio return, you would multiply the weight of each fruit by its individual return and then add these results together. So, for apples: 50 percent weight times 10 percent return equals 5 percent contribution to the total portfolio return. For bananas: 25 percent weight times 5 percent return equals 1.25 percent contribution. For oranges: 25 percent weight times 0 percent return equals 0 percent contribution.

Adding these contributions together: 5 percent plus 1.25 percent plus 0 percent gives you a total fruit salad portfolio return of 6.25 percent.

In financial terms, if your portfolio was 50 percent stocks with a 10 percent return, 25 percent bonds with a 5 percent return, and 25 percent real estate with a 0 percent return, the portfolio return would be calculated in exactly the same way. You multiply each investment’s weight by its return and sum them up. This weighted average gives you a much more accurate picture of how your entire portfolio performed, taking into account the different allocations you made. This portfolio return reflects the overall growth of your total investment, considering the performance of each component and how much of your money was invested in each. It’s a crucial metric for understanding the overall success of your investment strategy.