Total Return: Understanding Investment Performance Fundamentals

Many investors utilize income-producing holdings such as dividend-paying stocks and/or bonds to generate cash flow within their portfolio. When analyzing the performance or appropriateness of these holdings, it is important to take into account not only the income generated, but also the change in principal value.

It is also important to factor in taxes. Once dividends are paid, the investor loses control over their tax bill as they must pay taxes. However, if you focus on total returns, investors can control their tax bill by managing capital gains effectively.

This approach is known as calculating the “total return.”

In this Insight, we define total returns, work through some illustrative examples, and explain why this concept is so important for growing long-term wealth.

What is Total Return?

In short, total return is a way to measure an investment’s overall performance, accounting for both capital appreciation (changes in price) and income generated (such as stock dividends or bond interest). 

Total return is such an important concept because it describes the full financial benefit an investor receives over a given period—and is considered by many to be the most accurate measure of performance.

How Total Return for an Investment is Calculated

The examples outlined below illustrate the basic mechanics of total return and how it can analyze wealth accumulation across some common financial scenarios.

Example One: Income Return

This example provides a simple illustration of how income is calculated for a given investment (in this case, a stock).

• Investor purchases $1,000 worth of Stock X
• Stock X distributes a $20 dividend every six months
• The income return for one year is 4% ($40 of total dividends divided by purchase price)

Example Two: Total Return After Stock Depreciation

In this example, the total return illustrates how dividend payments can partially offset asset depreciation.

• Investor purchases $1,000 worth of Stock Y
• Stock Y distributes a $20 dividend every six months
• In one year, the price of Stock Y falls to $800
• Total return for one year is -16% ($40 dividends minus $200 stock depreciation divided by purchase price)

Example Three: Total Return After Stock Appreciation

Finally, this example illustrates how the total return reflects combined income and asset appreciation.

• Stock Z distributes a $10 dividend every six months
• In one year, the price of Stock Z rises to $1,200
• Total return for one year is 22%.

Why Total Returns is the Most Complete Way to Think About Growing Wealth

The third example above indicates that even though Stock Z produced the least amount of income compared to Stock X and Stock Y, it actually provided the greatest increase in wealth since initial capital increased by 20%.

If this investor truly required the $40 of annual income, they could supplement the $20 dividend income by simply liquidating an additional $20 worth of Stock Z and still have $1,180 in stock remaining.

This outcome illustrates the concept of total return investing, the philosophy that investors should focus on an investment's overall return rather than prioritizing income or growth potential over the other.

Common Misconceptions Related to Total Returns

"Higher dividends always mean a better investment."

• A high dividend yield might seem inherently attractive, but if a company is paying out too much in dividends, it may not be reinvesting enough in growth. This can limit long-term returns and even put the company’s financial health at risk.

"Selling investments for cash flow is bad."

• Some investors hesitate to sell assets, believing it's better to rely solely on dividends or interest payments. In reality, a well-planned withdrawal strategy from a total return portfolio can provide the same cash flow while keeping investments optimized for growth.

"Total return doesn’t matter if I just want income."

• Even for income-focused investors, total return is key. A stock paying a 5% dividend but losing 10% in value may leave an investor worse off than one with lower dividends but higher appreciation. Looking at the full picture helps ensure long-term financial success.

Build a Portfolio Tailored to Your Personal Financial Goals

Total return is a powerful way to evaluate investment performance, but the right strategy depends on your unique financial goals, income needs, and risk tolerance. Whether you prioritize long-term growth, steady income, or a balance of both, a personally tailored portfolio can help you stay on track.

At Wealthstream Advisors, we work closely with clients to develop personalized investment strategies that align with their needs.

If you’re interested in refining your investment approach, we invite you to schedule a conversation with our team.