Understanding the concepts of risk and return and how they are interrelated is an important part of smart investment. Some people make the mistake of only looking at the return from an investment without also considering the risk.
What is Return?
The return on an investment is the reward you receive for investing your funds. These rewards typically come in two forms:
1. Income – An investment may pay a sum of money to the investor from time to time. For example, if you invested in a term deposit or bond, you get regular interest payments. If you invested in shares, the company may pay you dividends when it makes a profit. The amount and regularity of the income you receive will vary from one investment to another.
2. Capital gain – Apart from income, an investment may increase in value, allowing you to sell it at a profit (i.e. at a higher price than you bought it for). This is called capital gains. There is a downside of course, in that the investment could lose value instead, which means you would make a loss if you sold it.
Typically, returns are expressed as a percentage of the initial cost of the investment. These can be referred to as “income return” and “growth return”. The aggregate of the two is called the “total return” (refer to box on “Calculation of Return”).
Calculation of Return
Say you paid $1,000 for shares in Company X. If, over 1 year, Company X paid you $20 in dividends and your shares increased in value by $100 (to $1,100) your return for the year would be: