What is a return?
Learn what return means, how profit and loss work, and how the return-on-return effect can make an impact.
For investors, ‘return’ is a key concept: it refers to the earnings generated by an investment. In this lesson, you will learn what return means, what happens when you reinvest your returns, and how return is calculated.
What is a return?
Simply put, return is the difference between the price you paid for your investments (cost of acquisition) and the price they are currently worth in the market (the market price). Since market prices move up and down, your return is constantly changing. It’s expressed as a percentage, i.e. 6% return.
Return, profit and loss
Return can be positive or negative:
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Positive return – your investments are worth more than the purchase price. If you sell them now, you make a profit.
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Negative return – your investments are worth less than the purchase price. If you sell them now, you realise a loss.a
Dividends and interest
In addition to changes in market price, investments can generate income in other ways: dividends or interest.
You may receive dividends when you invest in shares. When you invest in tradable loans called bonds, you may be paid interest.
What is a dividend?
Dividends are part of a company’s profit that it decides to distribute to their shareholders. Most of the time, dividend distribution takes place yearly, biannually or quarterly.
The return-on-return effect
The possibility of earning a positive return is what makes investing attractive. But there’s another aspect to returns that is important to understand.
If you don’t withdraw your returns and reinvest them instead, the return-on-return effect starts to work for you. This means that the returns you’ve already earned begin to generate returns themselves.
This sees you building returns on top of returns, effectively growing your money exponentially.
Keep in mind that returns can also be negative. Thankfully the return-on-return effect doesn’t apply the other way round.
Fig. 1 The return-on-return effect
The value of your investment can fluctuate. Past performance does not indicate future results.
Takeways
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Return is the earnings on your investments.
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Return can be positive (profit) or negative (loss), and it only becomes realised when you sell.
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By reinvesting your returns, your wealth can grow exponentially (the return-on-return effect).
Disclaimer: Peaks is an execution-only service and does not give advice.
Which statement is correct?