What Do We Mean By Profit or Loss For An Investment Portfolio?
When most people hear “profit and loss” they immediately think of a company’s balance sheet – but that is not what I am discussing here. I am discussing a portfolio of securities, which an individual may hold at Fidelity or at an investment manager to invest. Each portfolio has gains and losses which translates into profits or losses for the client whose account it is.
Why Is This Important?
When I started working in Investment Management, people would throw around the term “P&L” or “purchases flowing into the investment return.” Well, I challenge you to to really describe what these mean. Maybe you don’t and thats how you landed on this site. I am here to explain it to you.
How Do You Calculate a Profit or Loss?
In layman’s terms, the proft or loss formula is:
What You Ended With – What You Started With – Anything Additional You Contributed + Anything You Took Out
In “performance speak” it is:
Ending Vaue – Beginning Vale – (Contributions – Withdrawls)
Defining Ending Value, Beginning Value, Contributions and Withdrawals
Ending Value (what you ended with): The value of the investments at the end of the period
Beginning Value (what you started with): What you put in at the beginning, or if you are measuring from a certain point in the past it is the value at that point
Contributions (anything additional you contributed): If you put extra money in, then any increase in value due to this needs to be subtracted
Withdrawals (anything you took out): If you took money out, then that is extra money that the portfolio earned that is not refelected in its values anymore so you need to add it back in
What’s “behind the curtain” of the Ending Value -Beginning Value?
All of the following are reflected in the change from the beginning value to the ending value:
Price Changes of Holdings: Changes in price of the securities you hold
Purchases: Change in price from the amount you purchased it for (including transasction costs) to the value at the end of the measurement period
Sales: Change in price from the value you last held it at to the amount you sold it for, deducting any transaction costs from the sale proceeds
Corporate Actions: When you hold a security, the company behind that security may decide or have promised to give you (the shareolder, bondholder) cash or shares, sometimes in exchange for something. This includes the most common dividends and coupons. It also includes class actions, which is proceeds given to investors due to a litigation.
All of the following are examples of contributions and withdrawals, which are included in the change from beginning to end value, but are then taken out to calculate profit or loss:
Client contribution: you are adding cash or securities to the portfolio
Client withdrawal: you are removing cash or securities to the portfolio
Management fees: If you are paying someone to manage the portfolio, the fees will be taken out as a withdrawal when calculating a gross of fee return
A class action when the firm determines it should not get credit for the proceeds
When calculating performance on the security or asset class level, any flows between the securities or asset classes will be captured as an inflow or outflow.
What is Gross Profit or Loss versus a Net Profit or Loss?
You may hear the terms “Gross P&L” and “Net P&L.” In the performance world, the standard difference between the two is fees. However, there could be other definitions for gross and net so it is important to clarify the terminology if you are unsure.
“Gross” is defined as the number that is calculated before something is “netted out” or subtracted. For example, if fees are the only difference, then Gross P&L is the amount before fees are paid and Net P&L is the amount after fees are paid:
Net P&L = Gross P&L – Fees
If taxes are the difference:
Net P&L = Gross P&L – Taxes