Cumulative Return: Definition, Calculation, and Example

What Is Cumulative Return?

Cumulative return represents the total gain or loss of an investment over a specific period, expressed as a percentage. It captures the raw growth or decline of an investment's price, without annualizing the rate. Investors often analyze cumulative returns to see the long-term impact on their portfolios, including the effect of reinvestments, fees, and taxes.

Deep Dive into Cumulative Return

The cumulative return of an asset that does not have interest or dividends is easily calculated by figuring out the amount of profit or loss over the original price. That can work well with assets like precious metals and growth stocks that do not issue dividends. In these cases, one can use the raw closing price to calculate the cumulative return.

On the other hand, the adjusted closing price provides a simple way to calculate the cumulative return of all assets. That includes assets like interest-bearing bonds and dividend-paying stocks. The adjusted closing price incorporates the impact of interest, dividends, stock splits, and other changes on the asset price. So, it is possible to obtain the cumulative return by using the first adjusted closing price as the original price of the security.

Key Factors Affecting Cumulative Return

Evaluating Cumulative Return in Mutual Funds and ETFs

A common way to present mutual fund or exchange traded fund (ETF) performance over time is to show the cumulative return with a visual, such as a mountain graph. Investors should verify if interest or dividends are included in the cumulative return. The marketing materials or information accompanying an illustration typically provide this information. These payouts may be reinvested or simply added as raw dollars in the cumulative return.

A key difference is that mutual funds often distribute capital gains to fund holders. This distribution usually comes at the end of a calendar year. It consists of the profits the portfolio managers made when closing out holdings. Mutual fund owners can reinvest capital gains, complicating the cumulative return calculation.

Beware of Cumulative Return in Advertisements

Many advertisements use the cumulative return to make investments look impressive. While often accurate, results can be exaggerated to provoke greed or fear. For example, someone might sight Amazon's cumulative return of over 100,000% between its initial public offering (IPO) in 1997 and 2020. Many tech companies had IPOs in the late '90s, but few matched Amazon's returns. Investors had to hold the stock through a bear market in 2000-2001, which cut its value by over 90%.

Precious metals are another area where investors need to look carefully at advertisements using total returns. Importantly, ads for bullion don't follow the same regulations as mutual funds and ETFs. Furthermore, these cumulative returns typically do not subtract storage costs or insurance fees, which are services that many investors demand. While precious metals ETF fees are generally lower, they also need to be deducted from returns for the commodity to obtain the cumulative return that investors actually received.

The Impact of Taxes on Cumulative Return

Taxes can also substantially reduce the cumulative returns for most investments unless they are held in tax-advantaged accounts. Taxes are a particular issue for bonds because of their relatively low returns and the unfavorable tax treatment of interest payments. However, municipal bonds are often tax-exempt, so cumulative return figures require less adjustment.

Long-term stock investments enjoy the advantage of paying a relatively low capital gains tax, which is also usually easy to subtract from cumulative returns. The tax treatment of dividends is a much more complicated subject. However, it can also influence cumulative returns when funds reinvest dividends.

Cumulative vs. Compound Return: Key Differences

Along with the cumulative return, an ETF or other fund usually indicates its compound return. Unlike the cumulative return, the compound return figure is annualized. Cumulative returns may seem more impressive than the annualized rate of return, which is usually smaller. However, they typically omit the effect of the annual expenses on the returns an investor will receive. Annual charges an investor can expect include fund expense ratios, interest rates on loans, and management fees. When worked out on a cumulative basis, these fees can substantially eat into cumulative return numbers.

Practical Example of Calculating Cumulative Return

For example, suppose investing $10,000 in XYZ Widgets Company's stock for a 10-year period results in $48,000. With no taxes and no dividends reinvested, that is a cumulative return of 380%.

The Bottom Line

Understanding cumulative return is crucial for evaluating the long-term performance of investments. While it provides a straightforward percentage of overall gains or losses, it does not account for time or annualized factors. Investors should be aware that reinvesting dividends and capital gains, taxes, fees, and the effects of time can significantly impact actual returns. It is important to compare cumulative returns from similar timeframes to make informed decisions. Always consider additional factors like interest, dividends, and expense ratios that influence the security's performance when assessing cumulative returns.