Return

Return is the gain or loss on an investment over a specified period, expressed as a percentage of the original investment. It measures how well an investment has performed and is the primary way investors evaluate the success of their investment decisions.

Understanding return

At its core, return answers a simple question: "How much money did I make (or lose) on this investment?" It is typically expressed as a percentage, making it easy to compare investments of different sizes.

Basic formula: Return = ((Ending Value - Beginning Value) / Beginning Value) × 100

Example: You buy a stock for $100, and it rises to $115

Return = (($115 - $100) / $100) × 100 = 15%

Simple analogy

Think of return like a report card for your investments. Just as grades tell you how well you performed in school, returns tell you how well your money performed while invested. An "A+" might be a 20% annual return, while an "F" might be losing 30% of your investment.

Types of returns

Nominal return vs. real return

Nominal return: The raw percentage gain before adjusting for inflation
Real return: The return after subtracting inflation, showing actual purchasing power gained

Example: If your investment returns 8% but inflation is 3%:

Nominal return: 8%
Real return: 8% - 3% = 5% (approximately)

The real return is what actually matters for building wealth.

Price return vs. total return

Price return: Only considers the change in price
Total return: Includes price change PLUS dividends, interest, and other distributions

Example: A stock rises from $100 to $105 (5% price return) and pays a $3 dividend:

Price return: 5%
Total return: ($105 + $3 - $100) / $100 = 8%

Always use total return

When comparing investments, always use total return. Dividends and distributions often account for 30-50% of long-term stock market returns. Ignoring them gives an incomplete and misleading picture of performance.

Absolute return vs. relative return

Absolute return: The actual gain or loss (e.g., "I made 12%")
Relative return: Performance compared to a benchmark (e.g., "I beat the S&P 500 by 2%")

Annualized returns

When comparing investments held for different periods, annualized return provides an apples-to-apples comparison by showing the equivalent yearly return rate.

Example: You earn 50% over 3 years

Simple average: 50% / 3 = 16.67% per year (incorrect)
Annualized return: (1.50)^(1/3) - 1 = 14.47% per year (correct)

The annualized formula accounts for compounding and gives a more accurate picture.

Historical average returns by asset class

Understanding historical returns helps set realistic expectations:

Asset Class	Average Annual Return (1926-2023)	Volatility
US Large-cap Stocks	10-11%	High
US Small-cap Stocks	11-12%	Very High
International Stocks	8-9%	High
US Government Bonds	5-6%	Low
Corporate Bonds	6-7%	Moderate
Gold	5-7%	Moderate
Cash/T-Bills	3-4%	Very Low
Real Estate (REITs)	9-11%	Moderate-High

Note: Past returns do not guarantee future performance.

The risk-return relationship

A fundamental principle of investing is that higher potential returns come with higher risk. This is why:

Stocks return more than bonds over time (but are more volatile)
Small-cap stocks return more than large-cap stocks (but are riskier)
Emerging market investments offer higher potential (with greater uncertainty)

Understanding this relationship helps you choose investments appropriate for your goals and risk tolerance.

Calculating returns for different scenarios

Single investment

You invest $10,000 and it grows to $14,000 over 4 years:

Total return: 40%
Annualized return: 8.78%

Regular contributions (Dollar-cost averaging)

When you invest periodically, calculating returns is more complex. You need to use methods like:

Time-weighted return: Eliminates the impact of cash flows
Money-weighted return (IRR): Accounts for timing of contributions

After fees and taxes

Real-world returns must account for:

Management fees (typically 0.03% to 1%+ annually)
Transaction costs
Taxes on dividends and capital gains

A fund that returns 8% but charges 1% in fees gives you only 7% net return.

Common return benchmarks

Investors often compare their returns against standard benchmarks:

S&P 500: US large-cap stock benchmark
Russell 2000: US small-cap benchmark
MSCI World: Global developed markets
Bloomberg Aggregate Bond Index: US bond market
Risk-free rate: Usually short-term Treasury bills

Beating your benchmark consistently over time is considered successful investing.

Setting realistic return expectations

What to expect

For a diversified portfolio of stocks and bonds, expecting 6-8% annual real return (after inflation) over the long term is reasonable. Anyone promising consistent 20%+ returns with low risk is likely misleading you. If it sounds too good to be true, it usually is.

Common mistakes with returns

Chasing past returns: Last year's winners often become this year's losers
Ignoring inflation: A 5% return with 4% inflation is only 1% real growth
Forgetting fees: Small fees compound into large amounts over decades
Short-term focus: Judging investments based on months instead of years
Ignoring dividends: Missing a major component of total return

Related terms

Compound: How returns build on returns over time
Dividend: A component of total return for stocks
Volatility: The variability of returns, a measure of risk
Drawdown: Negative returns from peak to trough
Risk premium: Extra return expected for taking on additional risk