Total return offers the best measure of a portfolio’s performance. It’s defined as the percentage change, over a specified period, of your portfolio’s value, adjusted to account for the reinvestment of all distributions of dividends and capital gains. Income dividends is the interest earned on bonds or cash investments, or the dividends paid from common stock holdings. Capital gains distributions come into play when securities are sold at a profit. (Or, conversely, when securities are sold at a loss which triggers a capital loss, that can offset realized gains.).
Total return is a useful tool for comparing the performance of your
portfolio against an appropriate benchmark (typically the return as stated
in the Investment Policy Statement part of your financial plan.).
Capital returns are unpredictable and can fluctuate significantly. But the impact of those fluctuations lessens over time. Income returns tend to be more durable and predictable than capital returns. Income returns are taxed at rates ranging from 15% to 39.6%, while capital returns are taxed at a maximum rate of 20%. Therefore, if you invest in a taxable account, a fund that produces mainly capital returns may be more tax-efficient than one producing primarily income returns.
|The table below shows how the
components of total return have differed over time for the three asset
Components of Total Return
Income Return Capital Return Total ReturnCash Investments 3.9% 0% 3.9%
(U.S. Treasury bills)
Bonds 6.1% –0.4% 5.7%
(long-term U.S. corporate bonds)
Stocks * 4.7% 6.5% 11.2%
* Standard & Poor's® 500 Composite Stock Price
Index Source: The Vanguard
Many investors confuse yield with total return and they tend to overemphasize dividend and capital gains distributions. Yield is just one component of total return and it measures current income (dividends or interest) produced and expressed as a percentage. Generally, yield is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. Yield does not include any capital gains distributions. Yield does not reflect portfolio fluctuation —which sometimes accounts for much of a total return number.
Dividend and capital gains distributions are key components of total return. How a portfolio's total return is apportioned can have important tax consequences. In a taxable account, most distributions are taxable, even if you reinvest them. But you are not taxed on price appreciation or depreciation until you sell. Therefore, you could end up keeping more of the return produced by the portfolio that makes fewer distributions.
Remember that your portfolio return figures are most meaningful when compared with the returns for an appropriate benchmark index which takes into account your particular investment mix, and purchasing and redemption activity. The Investment Policy Statement of your financial plan will outline the return your portfolio needs to achieve in order to reach your goals – whether they be to supplement your income from other sources, or to pass on as large a legacy as possible
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