When it comes to investing, there’s one metric that stands above the rest: total return . Historically, Australian-based investors have often split their investments between local and global investments. If this is you, understanding total return is crucial. Many investors only look at the capital value change in their investment account because they’re the numbers that are easiest to find. Don’t let this be you.
To correctly compare the relative performance of all your investments, it pays to compare them on a total return basis. This is a popular way of ensuring you’re making an apples for apples comparison.
Breaking down Total Return
Total return is a measure that seeks to capture the full performance of an investment over time. It consists of two main components: capital gains and income .
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Capital gains
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- Definition : Capital gains represent the increase in the value of your investment. This is the gain you make when the price of the asset you own rises above the price you paid for it.
- Example : If you bought an ETF at $100 per share and it later increased to $120 per share, your capital gain would be $20 per share.
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Income (Dividends or distributions)
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- Definition : Income in the context of total return typically refers to dividends or distributions paid out by the companies within the ETF or share. Dividends are a portion of a company’s earnings distributed to shareholders, providing a steady income stream in addition to the appreciation of the share price.
- Example : If the ETF pays a $2 per share annual dividend, this income contributes to the total return alongside any capital gains.
Total Return formula
This formula aims to encapsulate the full performance of an investment by adding capital gains and dividends together and then dividing by the initial investment amount. This gives you a percentage that represents the total growth of your investment over time.
Why Total Return matters
Now that we’ve broken down the components, let’s explore why total return is an important metric for investors.
- Performance insight : Unlike metrics that focus solely on price changes, total return considers all forms of return, including income. For investors in ETFs, which can pay dividends, this is particularly important. By considering both capital gains and income, total return can give you a clear picture of how your investment is performing.
- Comparative power : Total return allows you to compare different investments on an equal footing. Whether you’re evaluating Australian ETFs or global ones, total return gives you a clear comparison of their performance, accounting for both market growth and income. This is especially useful when deciding how to allocate your investment between local and international markets.
- Long-term planning : For long-term goals like retirement, understanding total return helps ensure your investments are on track. By focusing on total return, you can get a true sense of whether your portfolio is growing at a rate that will meet your future needs. Over decades, the compounded effect of reinvested dividends can make a substantial difference in your portfolio's value.
- Risk vs. reward : Total return can also help assess whether the returns you’re getting are worth the risk you’re taking. Higher returns might come with higher risks, but by focusing on total return, you can better gauge whether the balance is right for your specific risk tolerance. This is crucial for ETF investors, who often seek a diversified portfolio that balances growth and income.
A real-world example: ASX 200 vs. S&P 500 (2000-2023)
To illustrate the importance of total return, let’s compare two popular indices: the ASX 200 (representing the Australian market) ; and the S&P 500 (representing the US market) over the period from 2000 to 2023.
ASX 200
- Initial Value (January 2000) : 3,000
- Ending Value (December 2023) : 7,200
- Dividend Yield : Historically around 4% per year
- Total Return : Approx. 510%
- Annualised Total Return : Approx. 3.94%
S&P 500
- Initial Value (January 2000) : 1,500
- Ending Value (December 2023) : 4,000
- Dividend Yield : Historically around 1.8% per year
- Total Return : Approx. 316.67%
- Annualised Total Return : Approx. 5.26%
These figures show that while the ASX 200 had a higher total return over the period, the S&P 500’s higher annualised return means it grew at a faster average rate each year. For an investor with a 50/50 asset split between Australian and global ETFs, these numbers highlight the importance of considering both local and international exposure in your portfolio.
How a focus on total return can benefit you
For Australian ETF investors, total return can help to highlight the true performance of your portfolio. By focusing on total return, you can consider all aspects of investment performance, not just price changes. This is especially important in a diversified portfolio, where income from dividends can make a significant difference in long-term growth.
When evaluating your investments, it pays to consider the total return. It’s a reliable measure of whether your portfolio is growing as expected, and whether you’re on track to meet your financial goals. Whether you’re investing in local or global ETFs, understanding and focusing on total return can help you make better-informed decisions.
Investing isn’t just about picking the right stocks or ETFs – it’s about understanding how those investments contribute to your long-term financial success. Total return is a metric that helps to tie it all together, providing the most complete picture of your investment performance. For Australian-based investors, especially those with a global perspective, total return can benefit your investment strategy.
Happy investing!
