Investment Return: What It Means and How to Measure It

Investment return measures what an investment produces over a specified period. Return may be positive or negative.

A useful starting point is:

- **Value change:** how much the investment’s value rises or falls. - **Investment earnings:** payments such as interest or dividends. - **Total return:** the value change plus investment earnings. - **Rate of return:** total return relative to the amount invested, commonly expressed as a percentage.

When evaluating a return, also ask whether the figure includes fees, how long the investment was held, whether inflation is considered, and whether the return definition and cash-flow assumptions are consistent.

A basic rate-of-return calculation compares the total return with the amount invested:

**Rate of return = total return ÷ amount invested**

The result is commonly expressed as a percentage. For example, if an investment produces a total return of 8 on an amount invested of 100, the rate of return is 8%, assuming the figures use the same period and the same return definition.

Total return can include both a change in the investment’s value and earnings received during the period. Looking only at the price or value change can therefore leave out part of the investment’s return.

Several adjustments help make return figures more meaningful:

- **Time period:** A return earned over one period is not automatically comparable with the same percentage earned over a different period. For compounded returns held for different lengths of time, use equivalent annualized returns and keep the return definitions and cash-flow assumptions consistent. - **Fees:** Fees, commissions, and sales charges reduce the investor’s result. For fee-adjusted results, use the term **net return** and state whether the fee was included before or after the return was calculated. - **Compounding:** Compounding means earning returns on the original investment and on previously earned returns. - **Inflation:** A real rate of return accounts for inflation. It is commonly approximated by subtracting the inflation rate from the investment’s percentage return.

These measures answer different questions: a nominal return describes the investment result before adjusting for inflation, while a real return considers purchasing-power effects.

1. Distinguish price return, income return, and total return.

2. An investment rises from $1,000 to $1,080 and pays $20 in cash distributions. Calculate the simple total return before taxes and fees.

3. Explain why a positive nominal return can still correspond to a negative real return after inflation.

4. Distinguish arithmetic average return from compound growth over multiple periods.

5. Why should investment performance be evaluated over an appropriate time horizon and against relevant risk rather than by return alone?

6. Correct this statement: “A 10% gain followed by a 10% loss returns an investment to its starting value.”