Total Return: Definition, Formula To Calculate It, Examples (original) (raw)

What Is Total Return?

Total return, when measuring performance, is the actual rate of return of an investment or a pool of investments over a given evaluation period. Total return includes interest, capital gains, dividends, and distributions realized over a period. Total return accounts for two categories of return: income including interest paid by fixed-income investments, distributions, or dividends and capital appreciation, representing the change in the market price of an asset.

Key Takeaways:

• Total return is the actual rate of return of an investment or a pool of investments over a period.
• Total return includes interest, capital gains, dividends, and realized distributions.
• Total return is expressed as a percentage of the amount invested.
• Total return is a strong measure of an investment’s overall performance.

Understanding Total Return

Total return is the amount of value an investor earns from a security over a specific period, typically one year when all distributions are reinvested. The total return is expressed as a percentage of the amount invested. For example, a total return of 20% means the security increased by 20% of its original value due to a price increase, distribution of dividends (if a stock), coupons (if a bond), or capital gains (if a fund). It is a strong measure of an investment’s overall performance.

Significance of Total Return

Some of the best dividend stocks have low growth potential and produce small capital gains. Basing an investment’s return on capital gains alone does not take into consideration price increases or other methods of growing the stock’s value. For example, an investor buys shares of Company B, and the share price increases 24.5% in one year. The investor gains 24.5% from the price change alone. Since Company B also paid a dividend during the year, adding in the stock’s yield of 4.1% to the price change, the combined return is 28.6%.

The investor may wish to calculate dividend-adjusted return. This figure considers both the stock price appreciation and its dividends. The dividend-adjusted return provides a more accurate valuation of a stock's return.

Total return determines an investment’s true growth over time. It is important to evaluate the big picture and not just one return metric when determining an increase in value.

Total return is used when analyzing a company’s historical performance. Calculating expected future returns puts reasonable expectations on an investor’s investments and helps plan for retirement or other needs.

Average Annual Total Returns

When analyzing mutual fund performance, investors should analyze their average annual total returns for different periods. Comparing returns to a benchmark indicates how the fund has performed, relative to an index. When analyzing average annual total returns, it's important to remember:

• The numbers almost always reflect the reinvestment of dividends and capital gains distributions.
• Effects of sales charges may or may not be included. However, this information is disclosed with return numbers.

Example of Total Return

An investor buys 100 shares of Stock A at 20pershareforaninitialvalueof20 per share for an initial value of 20pershareforaninitialvalueof2,000. Stock A pays a 5% dividend the investor reinvests, buying five additional shares. After one year, the share price rises to $22.

To calculate the investment's total return, the investor divides the total investment gains (105 shares x 22pershare=22 per share = 22pershare=2,310 current value - 2,000initialvalue=2,000 initial value = 2,000initialvalue=310 total gains) by the initial value of the investment ($2,000) and multiplies by 100 to convert the answer to a percentage ($310 / $2,000 x 100 = 15.5%). The investor's total return is 15.5%.