Investment Return (often simply called 'return') is the profit or loss you make on an investment over a specific period. Think of it as the scoreboard for your money. When you plant a financial seed (your initial investment or principal), the return is the total harvest you reap over time, minus the cost of that original seed. This harvest can come in two main forms: an increase in the value of your asset (like a plant growing taller) and any income it produces along the way (like the fruit it bears). A positive return means your wealth has grown—congratulations! A negative return, unfortunately, means your investment has lost value. Understanding how to calculate and interpret your return is perhaps the most fundamental skill in investing, as it tells you whether your strategies are working or if it's time to go back to the drawing board.
Your total return is a combination of two key ingredients: the change in the asset's price and any income it generates.
A Capital Gain is the classic “buy low, sell high” profit. It’s the difference between what you paid for an asset and what you sell it for. If you buy a share of Company X for $50 and its price rises to $70, you have a $20 unrealized gain (or 'paper profit'). It only becomes a realized capital gain when you actually sell the share and lock in that profit. For value investors, seeking out companies trading below their Intrinsic Value is the primary path to achieving long-term capital gains.
Some investments are like hardworking employees that bring you a regular paycheck. This is income, and it can come in several forms:
Your Total Return is simply the sum of these two parts: Total Return = Capital Gain + Income.
Knowing the components is great, but you need to measure your success in a way that allows for easy comparison.
Calculating your return as a percentage is the best way to compare different investments, regardless of their size. The formula is straightforward:
Let's say you buy one share of a stock for $100. Over the year, it pays you a $3 dividend. At the end of the year, you sell the share for $112.
A 20% return sounds great, but it means very different things if it took you one year versus ten years to achieve. To make fair comparisons across different time horizons, we use the Annualized Return. This metric, often expressed as the Compound Annual Growth Rate (CAGR), calculates the average yearly rate of return your investment would have needed to achieve its final value, assuming the profits were reinvested each year. It smooths out the wild ups and downs, giving you a single, comparable number. An investor who made 50% in five years has a CAGR of about 8.4%, which is a much more realistic and useful measure of performance than simply dividing 50% by 5.
Value Investing has a unique and disciplined view on the concept of return.
For followers of Benjamin Graham and Warren Buffett, this distinction is gospel. Buffett's famous rule, “Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1,” is all about the return of capital—ensuring you get your initial investment back. A savvy investor's primary focus is protecting their principal. Only after you've reasonably secured the return of your capital, typically by investing with a Margin of Safety, should you focus on the return on capital—the profit. A speculator might chase a 50% return on a risky bet, but a value investor would rather accept a 12% return on an investment where the risk of a permanent loss is extremely low.
The return you calculate is your nominal return. But what really matters is your purchasing power. If your investments return 7% for the year, but the cost of living (Inflation) went up by 5%, your Real Return is only about 2%.
You might have more dollars, but you can only buy 2% more stuff with them. A true value investor always measures their success against inflation, aiming to grow their real wealth over the long haul.
Return never travels alone; its inseparable partner is Risk. The Risk-Return Tradeoff is a fundamental concept in finance: generally, to get a higher potential return, you must accept a higher level of risk. However, the goal of a value investor isn't simply to balance risk and return. It's to find opportunities where the relationship is lopsided in your favor—situations where you can aim for an attractive return with an unusually low probability of permanent capital loss. It's about getting paid handsomely for taking a risk that the market, in its short-term panic or euphoria, has wildly overestimated. That, in a nutshell, is the art of investing.