What Is a Return?

What Is a Return?

Let me explain to you what a return really means in investing. It's the gain or loss that your investment produces over a period of time. You can think of it nominally as the simple change in the dollar value of what you've put in. Or, you can express it as a percentage, which comes from dividing the profit by the initial investment amount.

Returns can show up as net figures, which subtract things like fees, taxes, and inflation, or as gross returns that just look at the raw price shift. This applies to all sorts of investments, even something like a 401(k).

Understanding a Return

As a prudent investor, you need to know that defining a return precisely depends on the situation and the data you're using. Terms like 'profit' can refer to gross, operating, net, before-tax, or after-tax figures. Similarly, 'investment' might mean selected, average, or total assets.

A holding period return is what you get over the time you own the investment, and it can be nominal or a percentage—often called the rate of return (RoR). For instance, a monthly return covers one month, and an annual return covers a year. People usually want the annual or year-over-year (YoY) return, which measures the price change from now to the same date last year.

To compare returns from different periods, you have to convert them to the same length, like annualizing them to year-long intervals.

Nominal Return

A nominal return is the straight net profit or loss in dollars before adjusting for taxes, fees, dividends, inflation, or anything else. You calculate it by taking the change in investment value over time, adding any distributions, and subtracting outlays.

Distributions vary by investment—they could be dividends, interest, rents, or other cash flows. Outlays might include taxes, fees, or costs to buy, hold, or sell. For example, if you buy $1,000 of stock, get no distributions, pay no outlays, and sell it for $1,200 after two years, your nominal return is $200.

Real Return

The real rate of return adjusts for price changes due to inflation or other external factors, keeping your purchasing power steady. This lets you see how much of your nominal return is actually real.

You should always check the real return before investing, since inflation and taxes can eat away at value over time. Also, consider if the risk matches what you can handle for that real return. Using real values, especially in high-inflation times, gives you a clearer view of the investment's worth.

Return Ratios

Return ratios are financial metrics that show how well an investment is managed by comparing assets or equity to net income, resulting in a percentage per dollar invested. You use them to check against benchmarks like similar investments or industry standards. For example, return of capital (ROC) is just getting back your original investment.

Return on Investment (ROI)

ROI is the percentage return, calculated by dividing the dollar return by the initial investment and multiplying by 100. If you get $200 back on a $1,000 investment, that's ($200 ÷ $1,000) × 100 = 20% ROI.

Return on Equity (ROE)

ROE measures profitability as net income divided by average shareholder equity, showing net income per dollar of stock investment. For a company with $10,000 net income and $100,000 average equity, ROE is 10%.

Return on Assets (ROA)

ROA is net income divided by average total assets, indicating profit per dollar in assets and if it covers capital costs. With $10,000 net income and $100,000 average assets, ROA is 10%.

Yield vs. Return

Yield and return sometimes mean the same in finance, but context matters—yield can be a subset, like income from fixed income as a percentage of price. A $1,000 bond with $50 annual interest has a 5% yield. Return includes that plus capital gains or losses from price changes. Pay attention to how the terms are used.

Frequently Asked Questions

Yes, you can have a negative return, which means a loss, just as positive means a gain.

The risk-return tradeoff means you expect higher returns for riskier investments to offset potential losses—low-risk like government bonds have lower returns than high-risk growth stocks.

Gross return is the absolute price change plus income over time; net return subtracts fees, commissions, and taxes—what you actually keep. Real return also factors in inflation.

Diversification spreads your investments across uncorrelated assets to potentially boost returns without much extra risk, reducing volatility while maintaining or improving expected returns.

The Bottom Line

In the end, a positive return means profit and negative means loss, usually quoted as a percentage including income like dividends and capital gains. To chase higher returns, you often take on more risk of losses.