Investment Performance Measured Many Different Ways Tax-Time Documents Provide Opportunity To Figure Returns

If you’ve collected a box of financial documents to do your taxes, it’s a good time to assess your investment performance last year. Most of us keep a mental tally or have a gut feeling about how we’re doing. But the overall view can hide successes and failures that may signal a need for change.

If you started 1996 with a $50,000 portfolio and ended with a $60,000 portfolio, you might think of it as a 20 percent gain and congratulate yourself. But suppose half of the $10,000 gain came from new savings you put in during the year? Now, it turns out your actual investment earnings were only $5,000.

And should you calculate your performance on the basis of a portfolio that started at $50,000 or one that started with $55,000? What if the $5,000 in new savings was added in dribs and drabs throughout the year?

The only way to get an accurate picture is to look at each investment individually. This is especially important for investments you held for only part of the year, since, obviously, a 5 percent gain made over three months is a lot better than 5 percent gained over a full year.

When the experts talk about investment performance, they use a variety of terms that can be confusing. Here, then, with thanks to the Institute of Certified Financial Planners, is a primer on the most important ones:

Yield. This is calculated by adding interest and dividend payments and dividing the total by the price of the investment. A certificate of deposit that was purchased for $100 and pays 5 percent a year in interest has a 5 percent yield. “Effective” or “compound” yield includes the interest earned on earlier interest payments that are reinvested.

Yield on stock is figured by dividing the total dividend payments by the stock’s current price. If the stock sells for $100 and pays $5 a year in dividends, its yield is 5 percent. If the stock’s price rises to $130, the $5 dividend represents a yield of only 3.85 percent.

Capital gain or loss. This is a percentage figured by dividing the change in an asset’s price by its price at the time it was purchased. A stock that goes from $50 a share to $60 a share has a 20 percent capital gain.

Total return. This is usually the best overall gauge of performance. It is figured by adding yield and capital gains (or losses) and dividing by the amount originally invested. If you paid $100 for a share of stock, and received $5 in dividends while the stock price increased to $130, you’d have a total return of 35 percent.

Average return. This is figured by adding the percentages returned each year and dividing by the number of years being considered. A stock with a total return of 20 percent the first year and 20 percent the second year would have an average return of 20 percent.

Average annual compound return. To take into account the effect of compounding, this takes the total return expressed in dollars, rather than percentages, divides by the amount originally invested, then divides that by the number of years being considered.

A $50 investment that grows at 20 percent for each of two years, would grow to $60 at the end of one year and $72 at the end of two years. The total gain of $22 is a 44 percent increase over the original $50, for an average annual compound return of 22 percent.

Note that average annual compound return can be deceptive if improperly used in place of average return. If your $50 investment had gained 22 percent for each of two years, you’d end up with $74.42 rather than the $72 you had after earning 20 percent each year.

Real return. This is total return minus inflation. It measures how your investment is gaining or losing in terms of actual purchasing power. If your return was 10 percent and the inflation rate was 3 percent, your real return was 7 percent.