Historical returns are a crucial metric when investing and building investment portfolios. Investors use historical returns to analyze the performance of securities, assess risk, and to gain insight into potential future returns. Historical returns provide investors with an understanding of how a security fares in different investment situations.

To calculate the historical return of a security, begin by subtracting the most recent price from the oldest price. This gives the overall change in price over the period. Next, divide that number by the oldest price to get the return expressed as a percentage. For example, if you have a stock that traded at $100 in May of 2019 and is currently at $125 in May of 2020, the return is 25% ((125-100)/100).

Investors examine historical returns to determine risk. Higher returns come with increased risk. For example, a security with higher historical returns could indicate more volatility, which could mean that the security could drop in price at any given time.

Looking at the correlation between different securities can also be informative. Correlations between different investments can reveal how much the returns of both investments move hand in hand. By studying how these correlations change over time, investors can determine how much diversification there is between two investments.

Investors also use historical returns to estimate future returns. That said, just because a stock or index has done well in the past, doesn’t mean it’ll perform well in the future. Risk must always be evaluated to account for unexpected events.

As such, understanding the historical return of an investment is a critical part of making smart decisions. By calculating the historical return, understanding how that return changes in different market climates and analyzing correlations between different investments, investors can gain an understanding of the past performance of a security and make an educated estimation of its potential future performance.