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 given period of time.
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.
BREAKING DOWN '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. 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). Total return is a strong measure of an investment’s overall performance.
Example of Total Return
An investor buys 100 shares of Stock A at $20 per share for an initial value of $2,000. 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 $22 per share = $2,310 current value - $2,000 initial value = $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%.
Importance of Total Return
Some of the best dividend stocks have small 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%.
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 return puts reasonable expectations on an investor’s investments and helps plan for retirement or other needs.