What Is a Return in Simple Terms?
When it comes to investing, a return is the increase or decrease in value of an asset over a specific period of time. Returns can be expressed either as a dollar amount or a percentage of the initial investment. For instance, if an investor bought a stock for $30, and a year later, its market value had increased to $45, the investor’s one-year return would be $15 or 50% ($15 / $30).
Returns are often expressed on an annual basis (like in the example above), but they can also be expressed over an asset’s entire holding period. For instance, if the investor above held the stock they purchased for a total of 3 years and 7 months (during which it fluctuated in value) and then sold it at a market price of $28, the investor’s holding period return would be -$2 or -6% (-$2 / $30).
Put simply, return is a measure of the performance of an investment over time. Positive returns are profits, while negative returns are losses.
What Are the Different Types of Returns? How Are They Measured?
Financial return is a fairly simple concept, but there are several different ways to measure it. Each type of return below is calculated to include or exclude certain factors.
Nominal Return
A nominal return is the net change in value of an investment over a time period, excluding any taxes or fees paid for the investment or cash flows (like dividends) received as a result of the investment. It is calculated by subtracting the purchase price of an investment from its current value.
Nominal Return Formula
Nominal Return = Current Value – Purchase Price
Total Return
Total return, unlike nominal return takes into account both taxes and fees paid for an investment and any cash flows received via the investment. It is calculated by subtracting the purchase price of an asset (including any associated fees and taxes) from the current value of the investment (including any dividends or cash flows received as a result).
Total Return Formula
Total Return = (Current Value + Any Cash Flows Received) – (Purchase Price + Any Taxes or Fees)
Note: The result of the above calculation can then be divided by (Purchase Price + Any Taxes or Fees) to produce a result that is a percentage instead of a dollar amount.
Real Return
Real return may or may not take into account the same factors as total return, but it then considers the impact inflation has had on that return over the time period in question. Inflation is a measure of how much the prices of goods and services have gone up over a particular period of time, usually measured via the consumer price index (CPI). In this sense, real return expresses the return of an investment in terms of purchasing power.
Real Return Formula
Real Return = (1 + Nominal or Total Rate of Return) / (1 + Inflation Rate) – 1
What Are Return Ratios?
Return ratios are financial metrics that are used to evaluate how effectively a company is generating profit using its investment dollars, assets, or equity. Investors and analysts look to these metrics to compare the performance of companies in similar industries.
Return on Investment (ROI)
Return on investment is a measure of the return generated by each dollar invested in an asset. It means the same thing as rate of return and is calculated the same way—by subtracting the purchase price of an investment from its current value, then dividing the result by the purchase price to yield a percentage return.
ROI Formula
ROI = (Current Value – Purchase Price) / Purchase Price
Return on Equity (ROE)
Return on equity is a metric that expresses a company’s net income over a certain period (usually a year) as a percentage of its total shareholders’ equity. The result is the amount of income generated per dollar of invested capital.
ROE Formula
ROE = Net Income / Shareholders’ Equity
Return on Assets (ROA)
Return on assets is a metric that expresses a company’s net income over certain period (usually a year) as a percentage of its total assets. The result is the amount of income generated per dollar of assets.
ROA Formula
ROA = Net Income / Total Assets
Frequently Asked Questions (FAQ)
Below are answers to some of the most common questions investors ask about returns.
Can Returns Be Negative?
If the value of an asset goes down instead of up over a period of time, its return for that period would be negative. For instance, if an investor bought a stock for $25 and sold it a year later for $15, their return would be -$10 or -40%.
What Does “Rate of Return” Mean?
When the phrase “rate of return” is used, it means that the return being discussed is expressed as a percentage rather than a dollar amount. For instance, the rate of return on a stock purchased for $55 and sold for $65 would be 18.18%. Rate of return is often abbreviated as “RoR.”
What’s the Difference Between Return and Yield?
While the two are sometimes used somewhat interchangeably, return typically refers to the change in the principal value of an asset, while yield usually refers to the cash flows generated by an asset. That being said, total return includes both principal gain/loss and cash flows generated.
What Is a Good Annual Rate of Return for a Stock Portfolio?
Because the stock market at large varies in performance quite a bit due to factors like bull and bear markets, recessions, and interest rates, no single annual rate of return can be considered “good” across the board.
For this reason, investors typically compare their portfolio returns to those of popular bellwether stock indexes that are used as gauges of the market at large. Most investors compare their annualized portfolio returns to those of the S&P 500 or Dow Jones Industrial Average indexes, but the Wilshire 5000 index may be the most accurate benchmark since it seeks to include every publicly traded American stock.
For Instance, if the S&P 500 returned 12% over the course of a year, and during that same year, an investor’s portfolio returned 21%, that investor’s portfolio would have “beaten the market” by 9%.
