Many investors look at their portfolios piecemeal. They measure an asset by how much money it made, or by growth. For investors taking a comprehensive view, however, there is the idea of Total Return. It includes dividends, capital gains, payments and distributions, and any other form of return.
How Total Return Works
Total return measures how much your investment in a particular asset has grown over time. It is expressed as a percentage of the original investment.
For example, say you invest $1,000 in ABC Co. stock. The stock then grows such that your investment is worth $1,200. Over the same period you receive $100 in dividend payments. As a result, you have made $300 in total over your original investment. This means that you have realized a total return of 30%.
Unless otherwise specified total return is typically measured over a 12 month period.
Forms of Growth
An asset’s total return includes all forms of value. Generally speaking, these fall into two categories: income and capital appreciation.
Income measures any form of payments that an asset can generate. This includes interest (for example the coupon payments issued by most bonds); dividends (such as those issued by many stocks); and capital gains distributions (typically issued by high-performing mutual funds and ETF’s). As an investor you realize the gains from income immediately.
Capital appreciation measures an increase in the asset’s value. This includes increased market value (such as when a stock’s price goes up or a piece of real estate increases in value); net asset value (typically used to measure the value of a mutual fund or ETF); and secondary market price (such as when a bond will sell for more or less than its face value based on market conditions).
As an investor you do not realize capital appreciation until you sell the asset. For example, if you own a stock that has gained $10 in value, you will have to sell the stock before you actually receive that $10. Once you have sold the asset, your profit turns from capital appreciation (the potential profits you would make if you sold the asset) into capital gains (the actual profits you made after selling the asset). Total return uses an asset’s capital appreciation.
The difference between income and capital appreciation is important. As a result of it, total return has both fixed and fluctuating elements. When an investment returns income payments, this is growth which has definitively happened. You cannot lose this money because you already have it. An investment’s capital appreciation, on the other hand, reflects potential value. Until you sell the asset it still has the potential to gain or lose value, taking your returns with it.
Annual vs. Cumulative Total Returns
The two most common forms of a total return analysis are Average Annual and Cumulative.
An average annual total return is the standard format. It calculates an asset’s total return over a 12 month period. Typically, it shows how the asset performed over the previous year based on either a hypothetical investment or your own initial investment.
A cumulative total return shows you an asset’s total return over a defined period of time. This can review either a shorter segment of time (perhaps collapsing the view to just six months if you are interested in short-term performance) or much longer. A longer-term cumulative review is common for investors who are considering mutual funds or ETF’s, as they often like to look at the fund’s total returns since inception.
With funds and other related assets, it is also common for a total return analysis to compare the asset against some pre-selected benchmark. For example a mutual fund might set its average annual total return against the performance of an S&P 500 index fund over that same period of time. This allows investors to compare performance across investments.
Total Return and Broker’s Fees
Many, if not most, total return analyses do not account for transaction fees that the individual investor might pay. This can include factors such as transaction fees (particularly for investors using online platforms), broker’s fees (for stock transactions) and sales charges (for mutual funds and ETF’s).
All of these charges can drag down your actual total returns.
Example of Total Return
Let us return to our example above. Say that ABC Co. is selling for $10 per share. You invest $1,000 into it, buying 100 shares. Over the following 12 months, the following happens:
- The stock price increases to $15 per share.
- ABC Co. pays a dividend of $5 per share.
- The stock price decreases to $12 per share.
- You buy another 100 shares, spending $1,200.
- The stock price increases to $14 per share.
To calculate our total return we would start with all of our returns:
- Stock sale – 200 shares at $14 per share = $2,800
- Capital Gains – The value of our shares (200 shares at $14 = $2,800) minus our combined investment ($1,000 initial investment and $1,200 subsequent investment = $2,200). $2,800 – $2,200 = $600 in capital gains returns.
- Income – Dividend payments of $5 per share at 100 shares = $500 in income returns.
- Total = $1,100 in returns.
Then we convert it into a percentage. To do that we apply the formula:
- Total Return = (Returns / Investment) x 100
Here that would be:
- Returns of $1,100
- Investment of $2,200
- 1,100 / 2,200 = 0.5
- 5 x 100 = 50
Our total return on this investment was 50%.
Using Total Return
Total return allows you to think about an investment holistically.
For any investment, certain factors can be deceiving. A small-value stock might double in growth, while returning only an extra $1 per share to investors. A major stock can add $20 per share to its value, but only increase your money by 10%. Another stock might (somehow) barely grow at all, realizing no capital gains but paying steady dividends to its shareholders.
Looking at the total return for an investment lets you think about it in terms of actual, realized value. For modern investors, this can be very useful.
The Bottom Line
Total return is a way of looking at every form of growth in an asset. It includes both capital gains (such as when a stock’s price goes up) and income (such as dividend and interest payments). It is expressed as a percentage and, ultimately, measures how much your investment has increased when accounting for all possible returns.
- Maximize your own total returns by working with the right financial advisor. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
- Many investors confuse an investments returns with its yield. You never have to make that mistake again, though. Learn the difference between these two key concepts, along with how a combination of strong yields and steady returns can help you meet your financial goals.
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