Total return is the percentage gain (or loss) of an investment when counting both price change and income.
People typically measure investments by the change in price over a period of time, usually 12 months. If an investor buys a stock for $10 and a year later it is worth $20, the return on that investment is 100%.
A given stock investment could have additional gains from dividend payments over that same period. If the stock in the above example pays a dividend of $1, the actual return is $21.
The total return is thus 110%, not 100%.
If the investor chooses to reinvest dividends automatically, that means they will own more of the investment than before. That’s a material change in the investment’s value and part of total return.
Interest payments on bonds also add to total return.
Total return is a powerful indicator of the value of an investment or portfolio over time.
Neophyte investors sometimes look at a falling market as a sign of bad investment performance. Savvy long-term investors know, however, that falling prices can be good news.
The reason why is ongoing contributions and reinvested income. For instance, a portfolio that contains both stocks and bonds might over a 12-month period experience no gain from stock price appreciation. Stocks might even be negative for the year.
A flat year doesn’t mean the portfolio is failing. Rather, falling prices can be interpreted as an opportunity to buy more investments at lower prices.
In some cases, a retirement saver might automatically inject cash every paycheck. A portfolio manager might take income from the bond side of the portfolio and choose to increase a stock position.
Many long-term portfolios rebalance automatically. Rebalancing means using cash to buy investments that have fallen in price. Cash can come from dividends and from bond interest payments.
In addition, many blue-chip stocks allow for dividends to be used to automatically increase the same position, depending upon the investor’s choices.
All of this activity adds to total return, which broadly is the value of a portfolio after 12 months time, taking into account all transactions and reinvestments.
For that reason, it’s better to look at the cash value of the portfolio rather than comparing stock values alone.
MarketRiders, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.