Investing in various assets is an effective way of building wealth. But it is important to review your investment performance regularly. One popular method of analyzing investment performance is by using rolling returns. Rolling returns are a type of analysis that measures the performance of an investment over different time periods. Thus, it provides a more comprehensive view of how an investment has performed.

What Are Rolling Returns?

Rolling returns are an investment performance measurement that calculates the average returns of an investment over multiple holding periods. In simple terms, rolling returns help investors to determine the average return that their investments have generated over a specified period, rather than just looking at the performance over a single time frame.

Why rolling returns are important

Rolling returns are considered an important metric for analyzing investment performance because they help investors to understand how an investment has performed over different market cycles. This can provide a more accurate representation of an investment’s long-term performance, as it takes into account the ups and downs of the market over time.

Differences between rolling returns and point-to-point returns

Point-to-point returns measure the total return of an investment over a specific time period, such as one year. Rolling returns, on the other hand, calculate the average return over multiple periods of the same length, such as the average annual return over a five-year period. Rolling returns can provide a more comprehensive view of an investment’s performance over time, while point-to-point returns only show the performance over a specific period.

How to Calculate Rolling Returns

Rolling returns are calculated by measuring the annualized returns over a certain period by continuously shifting the investment period by one day, week, month, or year. For example, if you want to calculate the 3-year rolling returns of an investment, you would calculate the returns for every 3-year period from the start of the investment until the present day.

1. Time frame and frequency

The time frame and frequency for calculating rolling returns can vary depending on the investment goals and the investment horizon. For long-term investments, 3-year or 5-year rolling returns may be more appropriate, while for short-term investments, daily or weekly rolling returns may be more relevant.

2. Dividends and fees

When calculating rolling returns, it’s important to adjust for any dividends received and account for any fees paid. Dividends received during the investment period should be reinvested, and fees paid should be subtracted from the investment returns. This ensures that the calculation accurately reflects the net returns of the investment.

How to Analyze Rolling Returns

1. Mean return

Mean return is a way to calculate the average return of an investment over a period of time. To calculate the mean return, you simply add up all the returns over a period of time and divide by the number of periods. This helps you to understand how much you can expect to earn from an investment over time.

2. Standard deviation

Standard deviation is a measure of how much the returns of an investment deviate from the mean return. It measures the volatility of the investment and helps you to understand how risky the investment is. If the standard deviation is high, it means that the investment is more volatile and risky.

3. Risk-adjusted return

Risk-adjusted return is a way to evaluate an investment’s return relative to its risk. It takes into account the standard deviation of the investment’s returns and adjusts the return accordingly. This helps you to compare different investments with different levels of risk and understand which investment gives you the best return for the risk you take.

4. Time horizon

The time horizon is the length of time over which you are analyzing the investment returns. When analyzing rolling returns, it is important to consider the time horizon, as it can affect the results. A longer time horizon may provide a more accurate picture of the investment’s performance, while a shorter time horizon may be more volatile and unpredictable.

Rolling Returns Vs. Point-to-Point Returns

1. Volatility

Point-to-point returns can be more volatile than rolling returns because they only consider returns at specific points in time, and those points may not be representative of overall performance. On the other hand, rolling returns take into account returns over a continuous period of time, which can smooth out volatility.

2. Historical returns

Point-to-point returns only consider returns over a specific period, while rolling returns consider returns over a range of periods. Rolling returns allow for a more comprehensive analysis of historical performance, making it easier to identify trends and patterns.

3. Accuracy of performance analysis

Rolling returns are generally considered more accurate for performance analysis because they provide a more complete picture of investment returns over time. Point-to-point returns can be skewed by extreme events, such as a sudden market crash or a strong bull market, which can distort the overall picture of investment performance. Rolling returns provide a more accurate and comprehensive investment performance analysis over a given period.

Using Rolling Returns for Mutual Fund Analysis

1. Comparing mutual fund performance

Rolling returns help in comparing mutual funds’ performance over different time horizons. Investors can use rolling returns to see how a mutual fund has performed during a specific period, which can help them compare it with other mutual funds.

2. Selecting mutual funds based on rolling returns

Investors can use rolling returns to identify mutual funds that have performed consistently well over different periods. By analyzing rolling returns, investors can select mutual funds that have generated better returns over a particular period and are likely to continue to do so.

3. Analyzing mutual fund risk-adjusted return

Risk-adjusted return helps in measuring the performance of a mutual fund while taking into account the level of risk taken by the fund manager. Rolling returns can be used to calculate the risk-adjusted return of mutual funds by calculating the Sharpe Ratio, which is the excess return of a mutual fund divided by its standard deviation. Investors can use the Sharpe Ratio to analyze the risk-adjusted return of a mutual fund over different periods.

Limitations of Rolling Returns

1. Data availability

Data availability refers to the amount and type of data that is available for calculating rolling returns. The limitation with using rolling returns is that they require a significant amount of historical data. In some cases, historical data may not be available or may be incomplete, which can impact the accuracy of the analysis.

2. Variability of rolling return calculations

Rolling returns are calculated using a specific time frame and frequency, which can lead to variability in the results. The limitation with using rolling returns is that different time frames and frequencies can produce different results, which can make it challenging to compare investments accurately.

3. Mean reversion

Mean reversion refers to the tendency of an investment’s performance to move back toward its long-term average. The limitation of using rolling returns is that they can be influenced by mean reversion. In some cases, a strong period of performance can be followed by a period of underperformance, which can impact the rolling return calculation.

4. Market conditions

Market conditions can have a significant impact on investment performance. The limitation of using rolling returns is that they may not fully capture the impact of changes in market conditions. For example, a period of strong market growth may result in a high rolling return, but this may not necessarily indicate that the investment is performing well in all market conditions.

Conclusion

In conclusion, rolling returns are a useful tool for analyzing investment performance, particularly for long-term investments such as mutual funds. They provide a more accurate picture of historical returns and volatility compared to point-to-point returns. However, there are limitations to their use, including data availability and the variability of calculations. Investors should use rolling returns in conjunction with other analysis tools and consider market conditions and potential mean reversion. Overall, understanding how to calculate and analyze rolling returns can help investors make more informed decisions about their investments.

FAQs

1. What is the difference between rolling returns and point-to-point returns?

Rolling returns are calculated over a specific period, and the starting point of the period is shifted forward by one day or week at a time, while point-to-point returns are calculated for a fixed start and end date. Rolling returns take into account the performance of an investment over various market conditions and time horizons, while point-to-point returns provide a snapshot of the investment’s performance over a specific period.

2. How often should I calculate rolling returns?

The frequency of calculating rolling returns depends on the investment goals, but it is recommended to calculate them quarterly, semi-annually, or annually to analyze the investment’s long-term performance.

3. Can I use rolling returns to analyze stocks?

Yes, rolling returns can be used to analyze the performance of individual stocks or portfolios of stocks over a specific period, taking into account various market conditions and time horizons. However, it is important to note that stock analysis requires additional fundamental analysis and research beyond just the use of rolling returns.

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