Holding Period Return

What is the Holding Period Return?

The holding period return is the total return earned on investment throughout holding an asset. This return is expressed as a percentage. Its primary purpose is to evaluate an investment based on its return within the holding period.

It is an essential measurement in investment management to understand an asset's financial performance. In addition, it can be used to compare the versions of other investments held for different periods. 

There are two sources of income for every investment. These two sources are capital appreciation and income. Capital appreciation involves increasing stock prices, thus selling an asset at a higher price. Payment includes dividends being paid out by the company.

Using these two metrics, an asset's performance can be measured using the holding period return. This return is calculated based on the total return of the asset or portfolio coming from capital gain or income.

Holding Period Return Categories

There are two categories for holding periods. They are short-term and long-term periods:

• A short-term capital gain or loss is realized if the asset or portfolio is contained within a year
• A long-term capital gain or loss is realized if the holding period is more than one year. 

Generally, long-term investments have lower tax rates than short-term investments. If the asset is sold before one year and earns profits, it is taxable as a short-term capital gain. If it is above the threshold year, the taxation is comparatively less.

Short-term capital investments are preferred amongst companies with solid cash positions as they earn higher interest than traditional savings accounts.

The holding period helps compare investments based on their returns and the duration they were held. 

If the holding period was long and the return was short, this would yield a bad investment due to the opportunity cost of not having invested in an asset that gives higher returns during that long period.

It is important to note that the holding period return, although useful to determine the performance of a financial asset, isn't the only tool to base your judgment on an investment. 

Other qualitative factors, such as the company's business model, management, and reputation, should be considered alongside the holding period return extrapolating the quantitative side of the holding period return. 

The holding period return suggests investing in Amazon or Microsoft back in 2002 would be wrong. Hence, it's good to note that it is not the only factor that comes into play when estimating an asset's performance in the market. 

Calculating Holding Period Return

The formula for calculating the holding period return is:

 HPR = [(Ending Period Value - Initial Value)+Income] / Initial Value

Let's break this formula down more to understand each factor with different scenarios.

HPR (Simple Net Return: No Dividend)

For asset returns, let us consider time horizons P1 and P2. Let P1 be the price of an asset at time one and P2 be the price of an asset at time 2.

If there is no cash flow (e.g., no dividend) in this 1, 2-time interval, we speak of the one-period simple net return. So, the one-period simple net return of an asset can be defined by:

= P2 - P1/ P1

OR can use

= (P2/ P1) - 1

Example of Holding Period Return

For example, a non-dividend paying stock is bought for $10 in period one, and we sell it in period 2 for $12.

= P2 - P1/ P1

12 - 10/ 10 = 0.2 or 20%

Or

= (P2/ P1) - 1

= (12/10) - 1

= 1.2 - 1

= 0.2 or 20% 4

HPR (Including a Dividend)

Suppose you have the following:

1. The initial price of the indexed stock at $100
2. The period of a year
3. A cash dividend of $4
4. Final price of index stock at $110

Then your expected capital gain will be $10, so your capital gains yield will be $10/$100 = .10 or 10%. So the HPR is the sum of the dividend yield plus the capital gains yield, 4% + 10% = 14%.

 (P2 - P1+ Cash Dividend) / P1

= ($110 - $100 + $4)/ $100

= .14 or 14%

This definition assumes that the dividend is paid at the end of the holding period. Therefore, when dividends are received earlier, the report ignores reinvestment income between receiving the dividend and the end of the holding period.

The percentage return from dividends, cash dividends/beginning price, is called the dividend yield, so the dividend yield plus the capital gains yield equals the HPR. HPR on a bond would use the same formula, with interest or coupon payments taking the place of dividends.

HPR (Based on external cash flow in/out of the investment)

This cash flow is from an external source (i.e., you add money from your pocket to the investment or withdraw from it to spend on your home expenses). So, it is not like a dividend from the investment itself.

How do you determine the returns on your investments? And how does that figure stack up against the experts, the S&P 500, or your investment advisor?

The reply may appear straightforward:

(P2 Ending of year value) / (P1 Beginning of year value) – 1 = P2 - P1/ P2 Return for the year

Not exactly. At least not if you added or removed money throughout the year. These behaviors need to be changed. After all, you shouldn't gain anything from adding cash, just as you shouldn't be penalized for removing cash (which lowers the return figure) (which boosts the final number).

How do you fix that? How can you go deeper to determine the performance of your investment choices, the statistic that matters?

It is simpler than you may imagine.

Measure the return between any two cash flow events to get started. You need two things for this: the portfolio's value just before the cash flow and the amount of cash flow.

Suppose you have a portfolio with the following:

1. An ending value of $1000
2. An initial value of $900
3. A $10 distribution (dividends)
4. A $50 cash flow

Plug in the values as we usually see from the formula, but add the cash flow to the initial value.

HPR = ($10 +$1000)/$900 -1

HPR = 12.22%

(The wrong answer)

HPR = ($10 + $1000)/($900+$50) -1

HPR = 6.32%

(The right answer: correcting for cash flows)

The $50 was simply a deposit. If not included in the formula with the initial value, it would have been assumed that the $50 deposit was the outcome of the investment when, in reality, it was only a deposit.

Written and Researched by “Jad Shamseddine” | Linkedin

Reviewed and Edited by Abhijeet Avhale | LinkedIn

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