Stock Total Return
We begin our illustration with a share of XYZ Company that is bought for $30 at the beginning of the year. During the year, its price fluctuates, but it closes the year at $33, which represents a nice percentage return on the investment of 10% ($3/$30).

But the deal gets even better, because XYZ paid an annual dividend of $1 per share. This dividend equals an additional 3.3% return ($1/$30). Adding together the capital appreciation (price increase) of 10% and the income return (dividend) of 3.3% gives us a one-year total return for XYZ Company stock of 13.3%. However, remember that unless you sell XYZ stock, the price appreciation gain remains in the stock price, or is unrealized.

Related Reading:

Fund Total Return
With mutual funds, explaining total return is a bit more complicated. We begin with a share of the ABC Fund, which is purchased at its net asset value (price) of $16 per share. A fund's NAV is derived by dividing the value of its portfolio securities (the fund's assets), less any accrued fees and expenses (the fund's liabilities), by the number of fund shares outstanding. Here's an illustration of the computation of net asset value for the ABC Fund:

The fund's cash and cash equivalents = $200,000
The fund's stock holdings at market prices:

10,000 shares of Company X @ $50 = $500,000

20,000 shares of Company Y @ $30 = $600,000

50,000 shares of Company Z @ $8 = $400,000

Total market value of stock holdings = $1,500,000

The fund's total assets = $1,700,000
Less the fund's liabilities = $100,000
The fund's total net assets = $1,600,000

The fund's total shares outstanding: 100,000

The fund's NAV: $16 ($1,600,000/100,000)

Remember that mutual funds are priced once a day, at the end of the day. Unlike stocks, where prices are moved by the supply and demand forces of the marketplace, fund prices are determined by the value of the underlying securities in the fund.

In our example, ABC is a hybrid stock/bond fund with a growth-income orientation. Apart from capital gains, its individual portfolio holdings will generate dividends and interest. By law, mutual funds must distribute these to the fund's shareholders. ABC's income distribution (its dividends to shareholders) for the year amounted to $1 per share. In addition, the fund's trading activities (the buying and selling of securities) generated a realized capital gain of $3 per share that ABC also distributed to its shareholders.

The ABC Fund passed along all the earnings and capital appreciation it generated - $4 ($1 in dividend distributions and $3 in a capital gains distribution) to its shareholders for a total return of 25% ($4/$16). Here again, unlike a stock, by paying out all its capital gains, the ABC Fund's price, or NAV, remains at or close to $16. In this scenario, if a fund investor only focused on the movement in ABC's NAV, the results would not look very good. It's even possible for a fund's NAV to decline, but still have good income/capital gain distributions, which will be reflected in a positive total return.

Obviously, a fund's NAV does not tell the whole mutual fund performance story, but its total return does. It captures a fund's changes in NAV, its income distribution and capital gains distribution, which, as a whole, are the true test of fund's return on investment.

Taxes

Related Articles
  1. Financial Advisor

    Advising FAs: Explaining Mutual Funds to a Client

    More than 80 million people, or half of the households in America, invest in mutual funds. No matter what type of investor you are, there is bound to be a mutual fund that fits your style.
  2. Investing

    Trading Mutual Funds for a Living: Is It Possible?

    Find out why trading mutual funds for a living isn't your best bet, including how funds discourage short-term trading and which options may better serve you.
  3. Investing

    How Mutual Fund Managers Pick Stocks

    Learn about how mutual fund managers choose stocks based on the type of funds they manage and the investment goals of the funds' shareholders.
  4. Investing

    How Tax-Efficient Is Your Mutual Fund?

    Learn about factors that influence the tax-efficiency of your mutual fund, how income from your investment is taxed and what to look for when choosing a fund.
  5. Investing

    The 5 Best American Funds

    Discover five of the best-performing mutual funds offered by American Funds, based on the funds' five-year average annualized returns.
  6. Investing

    Expect Big Capital Gains Distributions from These Funds (AGTHX, ACRNX)

    The steady rise in the markets since 2009 has led to some outsized gains in a few funds that are finally being realized as long-term winning holdings.
Frequently Asked Questions
  1. Who determines interest rates?

    In countries using a centralized banking model, interest rates are determined by the central bank. In the first step of interest ...
  2. What's the Best Way to Contact Warren Buffett?

    Learn how to contact Warren Buffett and what kinds of contact is most likely to receive a response from him or from his company, ...
  3. What is the Financial Services Sector?

    A diverse group of companies, beyond banks and credit unions, comprises the financial services sector.
  4. Who are Whole Foods' (WFM) main competitors?

    Whole Foods' main competitors are Sprouts Farmers Markets and Trader Joe's. However, the recent acquisition by Amazon my ...
Trading Center