Trailing returns are a popular tool for measuring the performance of investment portfolios, mutual funds, and other financial assets. They provide a clear picture of an investment’s historical performance by calculating the returns over a specific time period, such as one, three, or five years. In this blog, we will explain the definition of trailing returns, how they are calculated, and how they can be used to analyze investment performance. Whether you are a beginner or an experienced investor, understanding trailing returns can help you make informed investment decisions.

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What Is Trailing Return?

Trailing return is the return on an investment that is calculated over a specific period, such as one year, three years, or five years, up to the present date. It is also known as the point-to-point return. This is because it measures the actual rate of return of an investment over a given period and helps investors determine the investment’s historical performance.

Why is Trailing Return Important?

Trailing returns are an essential tool for investment analysis because they provide investors with an idea of how an investment has performed in the past. It helps investors evaluate the risk and return of an investment over different time frames. Investors can use trailing returns to identify investments that are performing well consistently and make informed decisions based on the historical performance of an investment.

How is Trailing Return Calculated?

Time Period

Trailing return is calculated over a specific period of time, usually one year or less. This means that the trailing return measures the return of an investment over the past year or other chosen time period.

Formula

The formula for calculating the trailing return is very simple. It involves taking the ending value of an investment over a certain time period and dividing it by the beginning value of the investment over that same time period. The result is then expressed as a percentage.

Example

Suppose you invested $1,000 in a mutual fund one year ago, and today the value of your investment is $1,200. To calculate the trailing return over the past year, you would subtract the beginning value ($1,000) from the ending value ($1,200) to get $200. You would then divide $200 by the beginning value ($1,000) to get 0.2 or 20%. Therefore, the trailing return for this investment is 20% over the past year.

Types of Trailing Returns

Rolling Returns

Rolling returns are a type of trailing return that measures the average return of an investment over a specified time period. Instead of measuring the return at a specific point in time, rolling returns measure the average return over a series of overlapping periods. For example, if you were looking at the rolling returns of an investment over a 5-year period, you would calculate the average return over each consecutive 5-year period.

Annualized Returns

Annualized returns are another type of trailing return that measures the average return an investment generates over a year. It’s calculated by taking the total return an investment has earned over a specified period of time and dividing it by the number of years in that period. This gives investors an idea of how much they could expect to earn on an investment on an annual basis. Annualized returns can be used to compare the performance of different investments over the same time period.

Advantages of Trailing Returns

Incorporating Market Volatility

Trailing returns can give investors a better understanding of how their investments perform over time, taking into account market volatility. By calculating returns over a specific period, investors can see how their investments performed during periods of market turbulence or stability.

Comparison with Benchmark Index

Investors can use trailing returns to compare their investment performance with a benchmark index, such as the S&P 500 or a sector-specific index. By comparing their returns to the index, investors can assess whether they are achieving the desired level of performance.

Insight into Asset Allocation and Risk Management

Trailing returns can help investors make informed decisions about their asset allocation and risk management strategies. By analyzing the performance of different investments over various periods, investors can determine which assets provide the best returns and which ones have higher volatility. This analysis can help investors adjust their investment strategies to achieve their financial goals while managing their risk.

Disadvantages of Trailing Returns

Limited Historical Data

Trailing returns can only provide information about past investment performance, limited to the time period used in the calculation. This means that it may not reflect the current market conditions and factors that may affect future performance. It is important to keep in mind that past performance is not always indicative of future results.

Inability to Predict Future Performance

Although trailing returns can provide insight into the historical performance of an investment, it cannot predict future performance. Economic conditions, market volatility, and other factors can influence future returns. It is important to consider other factors such as the investment’s management team, fees, and overall investment strategy to make informed investment decisions.

Not Accounting for Fees and Taxes

Trailing returns do not account for fees and taxes that may affect the overall performance of an investment. Expenses such as management fees, transaction costs, and taxes can significantly impact the returns of an investment. Investors should consider the impact of fees and taxes when analyzing investment performance and making investment decisions.

Using Trailing Return for Investment Analysis

Evaluating Historical Returns

Trailing returns are a useful tool for evaluating how well an investment has performed over a given time period. By looking at an investment’s trailing return, you can get a sense of how much money you might have made or lost if you had invested in that investment over the same period.

Comparing Different Investments

Trailing returns can also be used to compare different investments to each other. By comparing the trailing returns of two or more investments, you can see which investment has performed better over a given time period.

Monitoring Investment Performance

Trailing returns can also be used to monitor the performance of your investments over time. By tracking the trailing returns of your investments, you can get a sense of how well they are performing and make adjustments to your investment strategy if necessary.

Conclusion

Trailing returns are a useful tool for analyzing investment performance, but it’s important to consider their limitations and use them in conjunction with other metrics. By understanding how to calculate and interpret trailing returns, investors can gain valuable insights into the historical performance of their investments and make informed decisions about future investment strategies.

FAQs

1. What is the difference between trailing return and rolling return?

Trailing return and rolling return are both measures of investment performance, but they are calculated differently. Trailing return measures the return over a specific time period that ends on a specific date while rolling return measures the return over a specific time period that “rolls” forward by a fixed interval. For example, a 5-year rolling return would measure the return of an investment over every possible 5-year period, rolling forward by one year at a time.

2. What time period should I use for trailing return calculation?

The time period used for trailing return calculation depends on your investment goals and time horizon. For short-term investments, a 3-month or 6-month trailing return may be appropriate. For long-term investments, a 1-year or 3-year trailing return may be more useful. Ultimately, the time period used should be consistent with your investment goals and reflect your desired holding period.

3. How does trailing return help with risk management?

Trailing return can help with risk management by providing insight into an investment’s historical volatility and risk-adjusted performance. By comparing a fund’s trailing return to its benchmark index, investors can gain a better understanding of how the fund has performed relative to its peers. Additionally, trailing return can be used to identify periods of underperformance and adjust asset allocation accordingly. However, it’s important to keep in mind that trailing return is a backward-looking measure and may not accurately predict future performance.

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