Cumulative returns, also known as compound returns, refer to the total return on an investment over a period of time, including both the initial investment and any subsequent returns. It is a measure of the growth or decline of an investment over time.
Cumulative returns can be calculated by taking the initial investment, adding all subsequent returns (such as dividends or capital gains), and then dividing the total by the initial investment. The result is expressed as a percentage.
For example, let's say an investor starts with an initial investment of $10,000 and earns a return of 10% in the first year, 15% in the second year, and 20% in the third year. The cumulative return would be calculated as follows:
(1 + 0.10) x (1 + 0.15) x (1 + 0.20) = 1.35 (or 35%)
This means that the investment has grown by 35% over the three-year period.
It's important to note that cumulative returns are different from annualized returns, which express the return on an investment over a period of time as an annual percentage. Cumulative returns take into account the total return over the entire period, whereas annualized returns express the return as if it were earned over one year.
It's also worth to mention that Cumulative returns can be used to compare different investment options, such as stocks, bonds, or mutual funds, to determine which one has performed better over a given period of time. They can also be used to compare the performance of an investment to a benchmark index, such as the S&P 500, to determine if it has outperformed or underperformed the market.
In conclusion, Cumulative returns refer to the total return on an investment over a period of time, including both the initial investment and any subsequent returns. It is a measure of the growth or decline of an investment over time. It's calculated by taking the initial investment, adding all subsequent returns, and then dividing the total by the initial investment. It's important to distinguish it from annualized returns. Cumulative returns can be used to compare different investment options and to compare the performance of an investment to a benchmark index.