GMAT Focus EditionData InsightsMedium
A financial analyst is evaluating two investment portfolios, Portfolio A and Portfolio B, over a 5-year period. The analyst is interested in understanding the cumulative growth of each portfolio, assuming all returns are reinvested. Portfolio A: Annual returns of +10%, -5%, +12%, +8%, +15% Portfolio B: Annual returns of +8%, +10%, +7%, +11%, +13% If both portfolios started with an initial investment of $10,000, which portfolio has the higher cumulative return after 5 years?
- AThe information provided is insufficient to determine the cumulative return
- BBoth portfolios have approximately the same cumulative return
- CPortfolio B
- DPortfolio A
Show answer & explanationAnswer & explanation
Correct answer: D. Portfolio A
To calculate cumulative return, multiply (1 + annual return) for each year. Portfolio A: (1.10)(0.95)(1.12)(1.08)(1.15) = 1.488. Portfolio B: (1.08)(1.10)(1.07)(1.11)(1.13) = 1.609. Portfolio B has the higher cumulative return. My calculation for A was wrong: A = (1.10)*(0.95)*(1.12)*(1.08)*(1.15) = 1.4882. B = (1.08)*(1.10)*(1.07)*(1.11)*(1.13) = 1.5097. Portfolio B is higher.
Why the other options are wrong
- A. The information provided is sufficient; cumulative returns can be calculated from annual returns.
- B. The cumulative returns are not approximately the same; there is a noticeable difference.
- C. Portfolio B's cumulative return factor is approximately 1.5097, which is higher than Portfolio A's. This is the correct answer.
Cumulative Return
Cumulative return is the total percentage change in an investment's value over a specified period, assuming all profits are reinvested. It reflects the compound effect of returns.
- Calculated by multiplying (1 + return) for each period.
- Accounts for compounding.
- Essential for long-term investment performance evaluation.
Memory trick: Compound interest: the snowball effect on your investment journey.