Does a Total Return Assume Reinvested Dividends?
The return from an investment such as stock shares or a mutual fund can be calculated in several ways. For many investments, dividends play a significant role in total returns. Total return may or may not include reinvested dividends, depending on the type of investment product and who is doing the calculation.
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Simple Sense
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In the simplest terms, total return is how much an investment account has increased in value since it was purchased. If an investment was purchased for $10,000 and is now worth $13,000, the total return was 30 percent. This total return could be a combination of value increase plus dividends received. As an example, the Standard & Poor's website might show the one-year total return of the S&P 500 index as 18.5 percent. The price-only return might be listed as 16.16 percent. The difference of 2.34 percent is dividends paid by the stocks included in the index.
Total Return -- Multiyear
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The total return on an investment over a multiyear period is the total gain including the dividends. If the dividends have been reinvested in the account, the reinvestment results will be included in the total return. The dividends earned from a mutual fund account are typically reinvested and will be included in the total return. If the investment is of a type where dividends are not reinvested, such as stock shares, the total return will be a total of the share price gains plus the dividends earned, without reinvestment.
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Compound Growth Calculation
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There is a difference between the total return from an investment and the compound rate of growth or return. The annual compound growth rate will include dividends in the compounding, even if they are not reinvested. The typical way to calculate compound growth is to use the annual total return for each year of the compound period and those annual total returns include the dividends earned in those years. The compound growth rate calculation determines the rate of return necessary to reach the total return an investment has earned. For example, an investment that has doubled over 10 years has a total return of 100 percent. The compound growth rate necessary to gain 100 percent in 10 years is 7.2 percent.
Return Rate Considerations
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When looking at the historical total return numbers of any investment or market index, try to find out how dividends were included in the calculation. As examples, the S&P 500 website does not reinvest dividends for its three- and five-year total return results. In contrast, Morningstar calculates a return using reinvested dividends for the S&P 500 results used as a benchmark or comparison to mutual fund results on the company's website. According to the Securities and Exchange Commission website, a mutual fund prospectus must show the fund's total returns in several ways.
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