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What is Relative Return?

Alexis W.
Alexis W.

A relative return refers to the comparison between two different types of investments. Relative returns are used to evaluate how well a given investment or stock is performing. While the term is most often used to compare and evaluate mutual funds, individual investors can also consider the relative return on their investment to determine whether the investment was a good decision or a bad one.

Most people invest in stocks, bonds, mutual funds or other types of investments to earn money on the money they invest. For example, a person might invest $100 US Dollars (USD) in a savings account that pays two percent interest. In such a case, he is aware that he is going to earn a two percent return on his money. The return in such a case is low because he is taking little risk; as such, he doesn't need to do a great deal of evaluation on what his return-on-investment is since he is receiving a fixed two percent and knows exactly what that return will be.

Man climbing a rope
Man climbing a rope

For other types of investments, return on investment can be more volatile and is thus important to understand. For example, if a person buys one share of a $600 USD stock and makes $1 USD on that stock, the return on investment was poor since the individual made less than one percent of his money. On the other hand, if that same individual buys a $1 USD stock and makes $1.50 USD on that investment, the return on investment was over 100 percent.

Because return on investment determines how well a particular investment performed, it is essential to be able to have an objective way of measuring the return. As such, investors can look at relative return. Relative return is arrived at by comparing the return-on-investment of two given investments to determine how the investments performed in relation to each other.

For example, assume that an investor invests in a technology mutual fund. That technology mutual fund has a 15 percent return on investment. This may seem like a good return on investment, but what if all of the other technology funds had a 25 percent return on investment. In that given situation, looking at the relative return is the best way to examine the performance of the mutual fund.

Since the other funds in the sector had a 25 percent return, the relative return of the particular investment — compared with the benchmark investment — was -10 percent. This suddenly looks like a much poorer rate of return. Relative to other investments he could have made within the industry, the investor made much less than he could have.

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