To calculate weighted average total return, you determine the weight of each investment, multiply each investment's return by its weight, and then sum the results. Here's a breakdown of the process:
1. Determine the Weight of Each Investment:
- The weight represents the proportion of the total portfolio value that a specific investment occupies.
- Calculate the weight by dividing the value of the individual investment by the total portfolio value.
- Formula:
Weight of Investment = (Value of Investment) / (Total Portfolio Value)
Example:
Suppose you have a portfolio with the following investments:
- Investment A: Value = $20,000
- Investment B: Value = $30,000
- Total Portfolio Value = $50,000
The weights would be:
- Weight of Investment A = $20,000 / $50,000 = 0.4 (or 40%)
- Weight of Investment B = $30,000 / $50,000 = 0.6 (or 60%)
2. Multiply Each Investment's Return by Its Weight:
- Multiply the return of each investment (expressed as a decimal) by its corresponding weight.
- Formula:
Weighted Return = (Weight of Investment) * (Return of Investment)
Example (Continuing from Above):
Assume:
- Return of Investment A = 5% (or 0.05)
- Return of Investment B = 10% (or 0.10)
The weighted returns would be:
- Weighted Return of Investment A = 0.4 * 0.05 = 0.02
- Weighted Return of Investment B = 0.6 * 0.10 = 0.06
3. Sum the Weighted Returns:
- Add up all the weighted returns to get the weighted average total return of the portfolio.
- Formula:
Weighted Average Total Return = Sum of (Weighted Returns)
Example (Continuing from Above):
- Weighted Average Total Return = 0.02 + 0.06 = 0.08 (or 8%)
Therefore, the weighted average total return of this example portfolio is 8%.
Summary:
The weighted average total return provides a more accurate reflection of overall portfolio performance because it considers the relative size of each investment. It allows you to understand how each investment contributes to the total return based on its proportion in the portfolio.
