Get the total picture of your investments
Especially when stock markets are flat or declining and when interest rates are rising, investors need to consider the total return of their investments. Paige Radke explains the importance of dividends and interest in a Money Talk Video. She spoke with Joel Dresang. A transcript is below.
Joel Dresang: Paige, I’m hearing more about the concept of total return in investment portfolios. You wrote an article about this for our website, explain what total return is.
Paige Radke: Well, Joel, when you’re looking at your investment portfolio, your return actually comes from two different places. The first is capital appreciation. This tends to be what people pay the most attention to, and it’s essentially just the upward movement in prices.
But in addition to capital appreciation, there’s also an income component. And that’s the dividends that you receive from investing in the stock market as well as the interest you receive from investing in bonds. So when you add capital appreciation and income together, you get your total return.
Joel: So why are we hearing more about this?
Paige: We tend to hear more about total return in years when the stock market has been flat or slightly negative, which was exactly the case in 2015. So if you look at the S&P 500 for instance, the price return was slightly negative, just short of 1%. But when you add in the dividends that were received from the stocks held within the S&P 500, you actually generated a net positive total return for the year.
Joel: And that same concept applies to bonds?
Paige: Exactly. And that’s especially true in periods of rising interest rates.
So, as you may know, the Fed met back in December of 2015 and decided to raise interest rates slightly. So, when interest rates go up, the price of your bonds actually goes down and you experience what we would call capital depreciation. So that tends to make people a little bit nervous, especially since bonds are supposed to be the safe money in your portfolio.
However, it’s important to remember that the interest payments you receive actually stay the same over time. So when you factor that into the decrease in prices, you may have a less of a negative return or even a positive return.
Joel: So, what difference can total return make?
Paige: Well, it’s especially important when you’re looking at the long term. And you can see it more when you look at the stock market, as opposed to the bond market. That’s just because bond prices tend to be more stable over time.
So, if you look at the S&P 500 once again and you go all the way back to 1926, the dividend component of that total return, has actually accounted for one third. So if you choose to leave that out and just look at the capital appreciation, you’re missing quite a big chunk of your overall performance.
Joel: Is that why value stocks tend to outperform growth stocks in the long run?
Paige: That’s exactly correct. So value stocks tend to be those more high-quality companies that have been around for a while, and therefore they’re more likely to pay a dividend. Which is why when you look at the long term, the value stocks outperform growth.
Joel: So, how should investors think of total return to put their portfolios in perspective?
Paige: When you look at total return, you look at the whole picture of your portfolio. So in times of high volatility, it’s easy to watch the news and get distracted by the downward movement in prices. But it’s always important to take a step back, look at the whole picture and remember that income component, which can hopefully offer some piece of mind going forward.
Paige Radke is an associate at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
(initially posted Feb. 23, 2016)