Portfolio return is a weighted average, not a simple one

The tempting shortcut

You hold three funds. This year they returned 12%, 8% and −10%. A quick average gives (12 + 8 − 10) ÷ 3 = 3.3%. It looks reasonable, and it is nearly always wrong, because it treats a ₹1,000 holding and a ₹5 lakh holding as equals.

Weights decide the answer

Suppose your portfolio is ₹10 lakh:

Total gain: ₹60,000 + ₹24,000 − ₹20,000 = ₹64,000 on ₹10 lakh, so the portfolio returned 6.4%, almost double the 3.3% from the simple average.

The same answer comes from weights. A is 50% of the portfolio, B is 30% and C is 20%:

0.50 × 12 + 0.30 × 8 + 0.20 × (−10) = 6.0 + 2.4 − 2.0 = 6.4%.

The simple average gave the losing fund a weight of one third, when it held only one fifth of the money. That is why it understated the result here. Had the weights gone the other way, with the loser holding the most, the simple average would have overstated it.

Why the weights drift

Weights are not fixed. A fund that returns 12% grows its share of the portfolio, and one that falls shrinks. At the end of the year in our example:

• Fund A: ₹5,60,000
• Fund B: ₹3,24,000
• Fund C: ₹1,80,000
• Total: ₹10,64,000

Fund A now holds about 52.6% of the money, up from 50%. Left alone year after year, the best-performing fund keeps gaining weight and your risk mix drifts from what you chose. Rebalancing with new money is one way to steer it back without selling.

Limits of this method

• One period only. It works when no money moves in or out during the year. Add a SIP and each instalment has a different holding time.
• For timed cash flows use XIRR. It weights each rupee by how long it was invested. Portfolio XIRR versus gain explains the difference, and the XIRR calculator does the maths.
• Over several years, compound. Weighted yearly returns must be chained, not added. A 6.4% year followed by a 2% year is 1.064 × 1.02, about 8.5% in total, not 8.4%.
• Costs are already inside fund returns. NAV returns are after expense ratios, so you do not subtract them again.

A short checklist for your own portfolio

1. List each fund's current value, not the amount you originally put in.
2. Write each fund's return for the same period.
3. Multiply each return by its weight and add them, or add the rupee gains and divide by the total.
4. Compare the result with the plain average. A large gap means a few funds dominate your outcome.
5. Check whether one fund explains most of the result, and whether that matches what you intended. Fund overlap can make this worse than it looks.

The takeaway

The portfolio does not care how many funds you own; it cares how many rupees sit in each. Know the weights, and your return stops being a surprise.

This post is educational, not financial advice. The funds and returns above are invented for illustration.