The rate of return on a portfolio is the ratio of the net gain or loss (which is the total of net income, foreign currency appreciation and capital gain, whether realized or not) which a portfolio generates, relative to the size of the portfolio.
The rate of return on a portfolio can be calculated either directly or indirectly, depending the particular type of data available.
Direct historical measurement of the rate of return on a portfolio applies one of several alternative methods, such as for example the time-weighted return or the modified Dietz method.
This method is particularly useful for projecting into the future the rate of return on a portfolio, given projections of the rates of return on the constituents of the portfolio.
The indirect calculation of the rate of return on a portfolio can be expressed by the formula: which is the sum of the contributions
A portfolio contains a cash account holding US$2,000 at the beginning of the period.
Although the loan liability has grown, so it has a positive return, its contribution is negative.
The portfolio suffers losses, and the owner sells all its holdings.
These trades, plus interest paid on the loan, leave US$100,000 cash.
A positive contribution to return on negative net assets indicates a loss.
It will be associated either with a positive weight combined with a positive return, indicating a loss on a liability, or a negative weight combined with a negative return, indicating a loss on an asset.
If there are any external flows or other transactions on the assets in the portfolio during the period of measurement, and also depending on the methodology used for calculating the returns and weights, discrepancies may arise between the direct measurement of the rate of return on a portfolio, and indirect measurement (described above).