Money Tips: Calculating Investment rate of return.
- 2002 10 Oct
Some investors only look at capital gains, forgetting that dividends are the stealth additions that add to returns and make a safety net for losses. Other investors focus on yield, forgetting that a drop in their stock or bond's price can take away years of dividends and interest payments.
Total return is the only way to measure an investment's performance and the only accurate way to compare returns on two investments -- for example - a stock with no dividend but plenty of price appreciation and a high-dividend stock with some gain in price. It's easy to figure total return on a security held for a full year: Start with the total value of the shares or bonds in a portfolio at year-end, then add interest or dividends received but not reinvested. Next step: subtract the value at the start of the year, and divide the difference by the starting value. Finally, convert it to a percentage.
For example, each of 100 shares you own of a stock worth $12 a share on January 1 pays $2 in annual dividends and appreciates to $16 by year-end. The year-end total value is $1,600 ($16 times 100) plus $200 ($2 in dividends times 100 shares), or $1,800. The beginning value was $1,200. So total return for the year is 50 percent -- $1,800 minus $1,200 (or $600) divided by $1,200, then multiplied by 100 to convert to a percentage. The calculation isn't usually that simple, however. Adding or withdrawing cash from a portfolio during the year changes the basis of the calculation. Dividends that are paid on different dates further complicate matters.
Traditional brokerage firms could make this information available on their statements but often don't. However, many online investors are finding that their online brokers do provide up-to-the minute profit and loss statements with options to use internet-based tools to automatically calculate accurate rates of return. In addition, investors can use software that calculates total return with a click of the mouse after the investor enters buy and sell prices and dividends or interest payments.
Whether you invest with a traditional broker or on your own with an online broker, seek out an accurate and consistent tool to measure your investment rates of return so that you can better identify the right investment choices in the future.