Understand The Total Value Of Your Investments With Total Return

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How do you know if your investments are performing well? Your first thought might be to look at a chart and figure out how much they’ve grown in value over time—but that’s not always the best answer. Instead, you need to understand total return, which takes into account how much an investment has gained in price over time plus the income it’s generated from interest or dividend payments. Total return gives you a full pictures of how well your investments are performing.

How Total Return Works

Total return is a method for calculating all gains from an investment by factoring in both price appreciation and income generation over a set period, commonly one year. Total return can also be referred to as the total rate of return, and it’s generally expressed as a percentage, which helps you compare the total return performance of different assets.

The starting point for calculating total return is basis, also called cost basis. What was the original purchase price of an investment? That’s your cost basis—appreciation above the cost basis is a capital gain (and depreciation from the basis is a capital loss). If you purchase a share of stock for $10 and one year later it’s worth $12, your capital gain is 20%.

Cost basis is only the starting point for total return, however. Next you factor in any income earned by an investment over time, such as dividend payments, interest income, non-recurring special dividends, or capital gains from a fund, among other distributions.

How to Calculate Total Return

To calculate total return, first determine your cost basis for the asset or portfolio of assets in question. Subtract the current value of the investment from the cost basis, add the value of any income earnings. Take the resulting figure and multiply by 100 to make it a percentage figure.

Here’s the basic total return formula:

Total return = [(Current Value – Cost Basis + Distributions) / Cost Basis] x 100

Let’s say you bought 10 shares of company XYZ, valued at $100 a share. Your total cost basis would be $1,000. Over time, the shares appreciated in value to $110, giving you a capital gain of 10%. XYZ also paid out annual dividends worth $2 per share, giving you income of $20 from your investment. Here’s how you would calculate your total return from investing in XYZ:

Total return = [($1,100 – $1,000 + $20) / $1,000] x 100

In this example, your total return would be 12%. Including the additional yield from dividends helps you understand your total return on investment (ROI). And when it comes to maximizing the total returns of your investments over the long term, dividend reinvestment—taking dividend payments and buying additional income generating securities—is essential.

Total Return Investing

Total return investing is a strategy where investors buy assets that deliver strong capital gains as well as impressive income yield, rather than focusing on only one outcome or the other. Total return investors build portfolios that generate wealth from both dividends and price appreciation.

Investors who need steady cash flow to pay for living expenses are best suited to total return investing. Like everyone, total return investors want to maximize the growth of their portfolios over time—but they are also indifferent when it comes to how they generate the cash flow they need. They’re equally happy to sell assets or take out dividend and/or interest payments to provide themselves with income.

Contrast total return investing with income investing or dividend investing, where the main focus is on building a portfolio that maximizes interest and/or dividend income, with much less focus on appreciation. For many retirees, income investing feels safer, because the cash flow that makes up their retirement paycheck comes from the yield generated by their investments, not selling assets.

Income investing is a capital preservation strategy—whereas a total return approach is just as happy to sell assets as take out dividend income to provide cash flow.

What Is a Total Return Index?

A total return index tracks the performance of its component stocks’ price appreciation (or losses) plus dividends or any other distributions or interest income. A total return index assumes that all distributions are reinvested in the stocks that issued them, providing a more accurate read on their components’ total return performance.

Of course not all stocks tracked by a total return index must issue income distributions or dividends. They assume that some companies reinvest earnings in the business rather than pay them out as dividends, or so-called retained earnings. A total return index can be contrasted with a price return or nominal index. The Russell 2000 is a good example of a total return index.

Reinvested dividends were responsible for almost 3% additional growth in eight leading global indexes for the 25-year period ending March 2018. This only serves to further highlight the importance of considering your total returns when investing.