What Is the Gross Rate of Return?
Let me explain the gross rate of return directly: it's the total rate of return on your investment before you deduct any fees, commissions, or expenses. You see this quoted over a specific time frame, like a month, quarter, or year. Compare that to the net rate of return, which subtracts those fees and costs to give you a more realistic picture of what you're actually getting.
Key Takeaways
- A gross rate of return shows an investment’s return before any expenses or deductions.
- A net rate of return accounts for costs like taxes, inflation, and fees.
- The net rate of return is harder to calculate precisely than the gross one, so you often look at a fund’s expense ratio to evaluate its return value.
- The Global Investment Performance Standards help you compare return characteristics across different funds.
Understanding Gross Rate of Return
When I talk about the gross rate of return on an investment, I'm referring to one way to measure a project or investment's gross profit. It usually includes capital gains and any income from the investment. In contrast, the net rate of return takes out fees and expenses from the final value. Here's the formula you need: Gross rate of return equals (final value minus initial value) divided by initial value.
Remember, the rate of return for any investment can be calculated in various ways, and you have to understand those differences.
Special Considerations
You can find details on how an investment company calculates returns in the fund’s prospectus. The gross rate of return is what they often quote in marketing materials for funds. If the return is for more than a year, it's usually annualized, giving you the geometric average return per year over that period.
In investment management, the CFA Institute's Global Investment Performance Standards (GIPS) set the rules for calculating and reporting returns. You can rely on these GIPS standards to compare investment returns across the industry.
Types of Gross Return
You often use return calculations when you're considering a new investment or checking how one is performing. The net return isn't as straightforward to spot as the gross return. That's why you might look at the expense ratio to see how expenses impact the fund's return.
The expense ratio is a key feature of mutual funds; it shows the percentage of fund assets that go toward expenses. You can use it alongside a fund’s total return and benchmark return to compare performance.
Take the Quantified STF Fund (MUTF: QSTFX), one of the top large-cap funds, as an example. Its fact sheet reports a gross rate of return, breaks down the expenses, and shows an expense ratio of 1.71%.
Gross Rate of Return vs. Net Return
For the net return, you deduct fees, commissions, taxes, and inflation effects. Inflation reduces a currency's purchasing power, so it affects your investment return. You should include inflation in calculating the real return. For instance, if annual inflation is 2% and your nominal return is 1%, you've got a negative real return over that year.
So, the gross rate of return can differ a lot from the net rate, which subtracts those fees and expenses. Consider a mutual fund with a 5.75% sales charge: the gross return will look very different from the net return after that charge is taken out.
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