An investment return is the gain or loss you make on an investment. Think of it as a report card for your money. It tells you how well your investment has performed over a period of time.

Measuring returns is essential. It allows you to compare different investments on an equal footing. Did your stock investment do better than your savings account? Calculating the return gives you a clear answer. This helps you track your progress toward financial goals and make smarter decisions about where to put your money next.

The most straightforward way to measure performance is by calculating the simple return. This shows your profit or loss as a percentage of your original investment. The formula is quite simple:

Let’s use an example. Imagine you buy a single share of a company for $100. One year later, the share price has risen to $115.

Here’s how to calculate your return:

1. Find the difference: $115 (Current Value) - $100 (Initial Value) = $15
2. Divide by the initial value: $15 / $100 = 0.15
3. Convert to a percentage: 0.15 × 100 = 15%

Compounding is what happens when your investment returns start earning their own returns. It’s a powerful process where your money can grow at an accelerating rate over time. Instead of withdrawing your profits, you reinvest them.

Let’s revisit our $100 investment, assuming it earns a 10% return each year for three years. If you didn't reinvest your earnings (simple return), you'd just earn $10 each year. But with compounding, the picture changes.

Notice that in Year 2, you earned a return on your original $100 and on the $10 profit from Year 1. By Year 3, your earnings were calculated on $121, not the initial $100. That extra $3.10 is the result of compounding. It might not seem like much at first, but over decades, this effect can be dramatic.

Now, let's test your understanding of these fundamental concepts.

Understanding returns is the first step in evaluating your investments and building wealth over time.